CEO Review
Finally, things are coherent in the oil markets. After a lot of early moves in products this year, the herd market had to deal with a pullback and consequent stopping out. We’ve priced out the maintenance period largely speaking or are in the process of it at least. That was the only bearish thing on the horizon for crude, and the impact was fleeting. The pullback was in products, whilst crude only really retraced in the DFLs in Balmo, and both of those seem only driven by the excess length in prompt contracts rather than anything material in the physical.
I would summarise where we think we are now in that we have a 2022-type picture here and I think this is being misunderstood. It makes complete sense that we are above $90/bbl in Brent, whilst the timespreads are backwardated; just over a dollar in the front. It is telling that people are saying Brent spreads are too high and there isn’t much upside. Relative to what? We are back into a fully-fledged bull market. The price distribution looking forward now has to be considered against the 2022 range, not 2023.
Stocks should start to draw aggressively soon and it’s a real headache for the US. They’ve shown us their hand. Energy security is a big election point and Trump will go after it. I think the Biden team know that and they are trying to solve it now. But it’s too late. They can’t afford a repeat of 2022 yet committing to so many oil purchases means they can’t do anything but exacerbate a price rally given the SPR situation. If there are going to be high prices it’s worse if there are high prices and a low SPR, so they just have to get on with it.
Admittedly, In 2022 I could never get excited by the rally. Black Friday in November 2021 made so much sense to me, a washout because everyone was way too bullish way too early. But it did materialise into a bull market of course, albeit it was fleeting. The excess in financial longs caused the market to self-implode in a deep sense of irony.
This time has a completely different backdrop in positioning. Funds if anything have been fading rallies. We also had a very low volatility start at the beginning of the year. The market has been slow to get out of thinking within this range. There isn’t an obvious hot geopolitical story right now that hasn’t been told a million times already, so you don’t have as much fear. This is very good for the bulls. The tail move by definition can only occur if people aren’t expecting it.
The profile of 2022 was hairy. Very hairy. Brent spread pullbacks of a dollar were common, let alone flat price. You have to adjust position size down as volatility starts picking up, that is such a key thing to monitor. We are also starting to think of how you hold bullish positions with the least downside and the first obvious one is options as volatility is not crazy high right now.
120 call options and even 2.00 CSOs on Brent and WTI offer good asymmetric risk still. But aside from options, swap rolls like a DFL roll really outperform in genuine bull markets and if anything go higher on pullbacks as traders protect the swap side and can’t do anything about the financial-influenced futures side. The same can be said about crack rolls, or if you want to avoid being short Brent, product flies should do the trick. They are scalable and can hold against volatility in the same way.
The famed strategy of bull markets of old was the roll-up trade. Buy deferred contracts that had been weakened by backwardation. That’s fine, but you just can’t carry as much within a VAR limit that way, and you have a lot of noise in between. Also, if you are relying on long-term strength greater than 3 months, you are very exposed to changes in policy that shook markets in 2022, but also 2020.
Trying to avoid buying what looks cheap on a relative basis is probably best. Buying what’s strong and will remain strong I personally prefer, especially in swap markets that have the physical behind it to reinforce at least 5% of the outright price and more like 33% of the price if a timespread or differential.
The other relevant topic for markets is China again. The CCP looks very serious now about its stimulus, which has taken a long time. Again there are long-term bears, from China itself from conversations we’ve been having, yet there is a strong pick up in activity. Macro sentiment is improving there with the recent stock rally, and Chinese oil trading is coming back on the buyside on key contracts. It’s not that it is bullish but it is less bearish than the doom and gloom traders have been pricing in with their shorts it’s hard to say anything but yes. The East is a beast and it’s awakening.
What does that say for pitiful Europe? They’re fucked. They are going to cut rates soon if analysts are to be believed, whilst they don’t seem to be aware of what is brewing. More scary inflation could be the death knell this time. That very general macro sentiment difference could materialise in oil markets.
Brent/Dubai is back negative, and the arbs and E/W contracts that were killed by China weakness and the Red Sea could come back with a vengeance into the second half of the year.
