By Alex Kimani
Retail investors with long positions in crude oil markets had little to cheer about in 2019 as the market failed to maintain the early-year rally as pipeline outages, geopolitical tensions and dramatic changes in ship fuel regulations shook up the global oil market leading to high volatility.
It was an annus mirabilis, though, for large oil traders, who took full advantage of the choppy markets and a spike in volatility to make a killing through oil trades.
Bloomberg has reported that dozens of large oil traders made billions of dollars in profits in the year, with many posting record earnings thanks to a rocky oil market. According to Marco Dunand, CEO of Mercuria Energy Group Ltd., one of the five largest independent oil traders in the world, 2019 was among the best years ever for the energy trading industry.
The good news for oil traders: the trading bonanza could be set for a repeat in 2020.
The current oil market could be headed for an encore as many of the catalysts that shaped last year’s market remain in force.
Independent traders were among the biggest winners, with the likes of Vitol Group and Trafigura posting record profits.
Trafigura, one of the largest commodity trading companies on the globe, was the first to provide an early glimpse into the rich pickings at its fiscal year ending report in September. The company revealed that its oil unit delivered a record gross profit of $1.7 billion for the full year.
Vitol, the world’s largest independent oil trader, is expected to report earnings near $2 billion, one of its best ever, while Mercuria’s CEO revealed that it also enjoyed a “very good year”.
But it’s not just independent traders that enjoyed last year’s bonanza.
In-house trading units of oil giants such as Royal Dutch Shell Plc, BP Plc and Total Plc
also pocketed billions of dollars in profits in the volatile market. These oil giants probably made the biggest bucks considering their oil trading divisions dwarf those by independent players. For instance, Shell trades the equivalent of 13 million barrels of oil per day, nearly double the 7.5Mb/d by Vitol.
According to a person knowledgeable in the matter cited by Bloomberg, Shell and BP made several billions of dollars apiece from oil trades last year.
A series of catalysts conspired to create the kind of volatility that these oil traders thrive on.
First off, scores of supply outages boosted the premiums that oil refiners pay over the benchmark price.
In 2019, Washington imposed fresh sanctions on Venezuela, disrupting flows.
Then in April, several countries halted Russian shipments into Europe via the key Druzhba pipeline amid concerns of contamination with pollutants.
The biggest supply disruption, however, came after Saudi exports were cut off following a major terrorist attack on the country’s key petroleum facilities in September.
Then there was the IMO2020 rules that force the shipping industry to use fuel with a lower sulfur content. The rules, which came into force in January, have resulted in increased volatility in the price of fuel-oil and marine diesel.
Shell is rumored to have made at least $1 billion in trades linked to the IMO2020 changes.
There were other factors at play, too.
Gunvor CEO Torbjorn Tornqvist said that 2019 was “up there among the best years ever” for the trading house, thanks to the company’s expansion into LNG, super-cooled natural gas that can be transported by vessel.Most of the world’s LNG is transported by LNG carriers in onboard, super-cooled (cryogenic) tanks.
The bumper trading profits for publicly traded companies is expected to soften some of the blow by low energy prices and asset write-downs that have overtaken the industry. Shell is expected to report 4th quarter and fiscal 2019 earnings on 30th January before market open while BP is expected to do the same on 2nd February.
More of the same?
So far, the current year is displaying the same kind of uncertainty that created turbulent oil markets last year.
The China coronavirus outbreak and continued inventory builds in the US market have been depressing prices.
Only a few weeks ago, nobody foresaw the epidemic risk factor with the first case reported in December. Second, crude stocks gained 3.5 million barrels in the week to Jan. 24– more than 7x market expectations with gasoline stocks rising to a record high for the 12th consecutive week to 261.1 million barrels pointing again at weak demand.
Meanwhile, tensions in the Middle East have somewhat dissipated but remain high. There are rumours that ISIS is taking advantage of the US-Iran crisis to make a comeback, though the United States has been downplaying the threat. The unlikely coalition between the US and Iran was responsible for pushing ISIS back, and expulsion of US troops from Iraq could give the jihadist group an upperhand and could lead to a another flare up in tensions in the region. The signing of the Phase One Trade Deal between Washington and Beijing also partly removed a major risk overhang from the oil market.
The ongoing events seem to support a rather bullish thesis by a leading industry prognosticator.
Two weeks ago, the US Energy Administration (EIA) published its latest short-term oil outlook where it predicted that inventory builds in 2020 and draws in 2021 would lead to Brent prices averaging $65/b in 2020 and $68/b in 2021. That’s considerably higher than the current Brent price of $57.44/barrel. The EIA says it expects, ‘‘…global oil prices to be affected by both the downward price pressures of relatively weak oil market balances and by the upward price pressures of geopolitical risk.’’
But that’s just part of the story.
This forecast assumes that Brent crude oil prices will decline in early 2020 through May 2020 as risk premiums slowly fade then climb from mid-2020 and into 2021 due to tightening market fundamentals. However, the EIA failed to account for a key supply disruption: Libya. As ING recently cautioned, outages in Libya–where production has been steadily declining amid a blockade–should not be discounted and could swing the market into a deficit as early as in the first quarter despite continuing lackluster demand.
It’s this sort of rocky backdrop that created excessive volatility in the markets in 2019 and led to record profits by oil punters.
Crude Oil Volatility Index, or Oil VIX (OVX) is a popular volatility indicator for oil traders. OVX tends to spike near market bottoms while lulls are more commonly seen near short-term market tops. After falling steadily in December, volatility in the oil market is once again spiking suggesting a bottom might not be far off.
Hedgers and professional traders tend to dominate the energy futures market, with hedge funds speculating on long- and short-term direction while industry players are taking positions to offset physical exposure. Retail investors tend to exert less influence in oil futures markets than in more emotional markets, like high beta growth stocks and precious metals.
That said, retail’s influence can rise considerably when crude oil trends sharply by attracting small players who are drawn into energy markets by table-pounding talking heads and front-page headlines.
Waves of greed and fear can intensify underlying momentum, thus contributing to epic climaxes and collapses while printing exceptionally high volume. Tight convergence between positive catalysts can generate powerful uptrends while the opposite rings true for negative elements.
With the oil futures market being extremely liquid and low margin costs offered by many brokers, retail traders with their fingers on the pulse, a keen eye on the charts and plenty of gumption can also partake in some of the oil profits the majors have been enjoying.