TRADING PLACES inside the oil futures market. Karen Matusic

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1 TRADING PLACES inside the oil futures market Karen Matusic

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3 Nymex Facts Biggest commodities futures market Volumes account for more than 10 times world oil production Started as a milk and butter exchange in 1872 First energy contract was in heating oil in 1978, Crude oil followed in 1984 and is today the most widely traded commodity contract in the world More than $4 trillion/year traded, 200 million b/d of paper barrels traded on Nymex, IPE Opec role as price setter diminished as Nymex seen as benchmark for many physical and OTC contracts

4 Let s get started Big mouths welcome Open outcry system (though computerized system ACCESS takes over at 4 pm to permit 22 hours of oil trade/daily) Trades completed in seconds 1,000 contracts trade in every minute Hazardous job blood drawn during Gulf War 1! How a trade works Customer rings a licensed commodity broker with buy or sell order Broker sends order to his floor trader via telephone or computer Order slip is prepared, time stamped and given to floor brokers in the trading ring

5 In the Ring Open outcry is literally an auction It s a deal when highest bid and lowest offer meet Broker then enters transaction on a card which shows: commodity; quantity; delivery month; price and broker s badge name and buyer s name (Interesting badge names like Id, Ego, Boom, Loud, Talk and even Nose ) Seller then throws the card into center of trading ring. Within one minute card is time stamped and sent to data entry room for keying into systems (and soon appears on screens) 972 feet of paper is swept up on Nymex floor every day!! Customers are then notified by originating brokers that the deal is complete

6 Nymex Facts Covering your tracks While the CFTC and the exchange are aware of each party in any given transaction, the market is not Some big players use several brokers to keep the size of their dealings close to their chest

7 Removing risk from risky biz Only commodity market regulated by Commodity Futures Trading Commission Market players protected in various ways The Clearing House Intermediary immediately after price in any deal is agreed (60-70 members big banks and financial institutions) Margin good faith deposits placed with clearers Marking to market (via daily resettlement that forces both sides to take profit or loss on a daily basis) Nymex only US futures market requiring commitment of trader data

8 Hedging Tool What are futures? Legally binding obligation to buy or sell a particular commodity at specific price, location on specific future date Same quality, quantity, delivery terms Most widely used for hedging (protection against fluctuating prices -- producers lock in prices to protect against price falls, refiners hedge against price rises) Hedgers are not out to get rich gambling on futures aim is steady revenue, costs Not as many oil producers/users hedge as one would think (Exxon, airlines, Saudis)

9 Buy Low, Sell High Speculators look for profits Unlike hedgers, they do not hold offsetting positions in the physical market Most are not even interested in supply-demand fundamentals computerized trend spotters Play important role by adding liquidity -$18 billion Can be called non-commercials large speculators holding multi-million dollar exposures

10 Funds not all the same Types of speculators Day or independent traders Jobbers Plain vanilla funds (pension mutual) Hedge funds/commodity pools Heart of speculating community. Manage money for wealthy investors (George Soros, Paul Tudor Jones)

11 Hi Tech When in doubt, blame technicals Using the past to predict the future Charters graph price movements to determine trends resistance/support/reversal, doubletops/double bottoms, head and shoulder Historical volatility based on time frame and price interval Moving Average (open, high, low, close, midpoint, average) to follow the trend signal Ratio determine overvalued and undervalued markets through price relationships

12 Still more technicals Relative Strength Index Study to measure markets s strength, weakness and determine whether market is overbought or oversold Stochastic Oscillator Computergenerated overbought/oversold indicator st Qtr 2nd Qtr 3rd Qtr 4th Qtr East West North

13 Yet more technical aids Open interest/volume Increasing volume considered indication that current price trend is strong, likely to continue Open interest the number of long or short positions in a contract that have not been offset. Considered indicative of market strength during period of rising prices or weakness during period of falling prices But if volumes are falling while prices are rising may be harbinger of price reversal

14 Options Two types Call gives holder right but not obligation to buy the underlying futures at specific price up to given time Put gives holder right but not obligation to sell Buy calls when you think prices will go up and puts when you foresee sideways to lower prices Target price is the exercise of strike price The buyer pays a premium, or the price of the option, to the seller for the right to hold the option at that strike

15 Options A wasting asset Premium declines as time passes Buyer has three alternatives exercise the option; liquidate it by selling or buying it back on the Exchange; or let it expire without value Why get involved? It allows hedgers to protect against adverse price moves while enjoying favorable price moves. Only cost is the premium. Less expensive than futures

16 Paper Barrels About 95% of oil traded on the Nymex never shows up as physical product Most hedgers close out positions before contracts expire, and then make or take their physical deliveries through people they usually buy or sell their actual supplies. Knowing that at any given time, however, someone may actually demand to buy your products, or sell theirs to you at that price, helps keep the value true to life.

17 Taking delivery If a company decides to take delivery, there are some options: Standard delivery Alternative delivery procedures Exchange for Physicals (EFPs) can choose trading partner, delivery site, product grade, timing. Price must be submitted to the Exchange and there is a nominal fee

18 CASE STUDY The refiner Has to buy 3,000 b/d or 90,000 bbls/month to run the refinery Worries about crude price rises, especially in winter Hedges purchases for high runs in December by buying crude futures to lock in Dec purchase prices a LONG HEDGE

19 Case Study cont. Step One In October, refiner buys 90 contracts (1,000 bbls = 1 Nymex futures contract for light sweet crude) for future delivery at average $19.50/bbl. The refiner is now NET LONG 90 contracts

20 Case Study cont. Step Two In late November, refiner buys 90,000 bbls of crude from producer for $19.80/bbl to meet December demand At the same time, refiner liquidates futures hedge or offsets the long position by selling futures. The refiner sells 90 contracts for average $19.80/bbl since prices did indeed rise as refiner anticipated The futures gain of 30 cts/bbl was applied to physical crude purchase costs Result refiner paid $19.50/bbl not $19.80/bbl savings of $27,000

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25 Thank you for your attention. Please feel free to ask any questions you might have at this time.

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