“We are not addicted to oil, but our cars are”, said a former CIA Chief, James Woolsey. That addiction is on the decline as we pen this paper. Love it, or hate it, but you cannot ignore it. Crude oil powers the planet. When global economy stutters, oil prices plunge.
Midway through 2023, crude oil demand appears wobbly on recession overhang and shaky economic recovery in China. Meanwhile, crude supply remains tight with OPEC+ scaling back production which has been compounded by limited investment in new exploration.
Over the long term, energy transition is set to fundamentally change the oil market. Consumers are shifting to EVs and renewable energy. In a befitting response, producers are reducing supply.
Energy transition will be anything but a straight line. It will create many risks and present many more opportunities.
This paper is set in two parts. First, we highlight key takeaways from a recent IEA report on crude oil outlook until 2028. Second, we explore hedging & trading instruments on the CME Group for participating in oil markets.
PART 1: KEY TAKEAWAYS FROM IEA CRUDE OIL OUTLOOK REPORT
The International Energy Agency (IEA) released Oil 2023 last week. This report describes in detail the changing dynamics in the oil market until 2028. It discusses key trends such as slowing demand growth, shifting producer growth, and the impact of energy transition on oil.
Recent crises have accelerated the energy transition. With COVID-19 plus rattled geopolitics, nations are increasingly more focused than ever on energy security and independence.
Ten key takeaways from Oil 2023:
1. Global oil demand to rise by 6% or 5.9M bpd between 2022 to 2028, reaching 105.7M bpd. Despite this, emissions will fall 11% with efficiency improvements.
2. Annual demand growth is expected to slow sharply in the coming years from +2.4M bpd in 2022 to just +400K bpd in 2028.
3. India and China will drive demand over the next decade while consumption among OECD countries will shrink.
4. Oil demand for gasoline will peak this year and start to reverse going forward with accelerated EV transition. Demand for transport fuels is expected to peak in 2026.
5. Jet fuel demand is still lagging 2019 levels by 13% and is expected to rise rapidly but only surpass pre-COVID levels in 2027 with expected efficiency improvements.
6. The petrochemical sector will replace the demand for transport fuels. Demand from LPG, Ethane, and Naphtha will increase by 40% from now until 2028.
7. Production growth from shale is expected to slow due to rising costs and lower prices. US shale will mature to a higher-return-lower-growth trajectory.
8. Global upstream oil and gas investment is projected to increase by 11% year-on-year in 2023, reaching USD 528 billion. This represents a rise from USD 474 billion in 2022.
9. Non-OPEC+ countries, including the United States, Brazil, and Guyana, will lead the medium-term capacity expansion plans. They are expected to contribute to a supply boost of 5.1M bpd.
10. By 2028, an additional 5.9M bpd of net production capacity will come online. The rate of new capacity building will decrease over time, aligning with projected demand growth.
Following four charts help visualise the large shifts underway in the crude oil market:
1. Price Sensitivity to Imbalance: Crude oil prices are highly sensitive to imbalances between production and consumption. Over the past 25 years, consumption has been marginally higher than production. Where deficit rises, spot prices rally.
2. Consumption between developed markets (DM) and emerging markets (EM): Consumption in EM will further outpace OECD countries. Consumption across EM overtook OECD in 2013 and this trend will be further entrenched. IEA forecasts that consumption in OECD countries will hit its apex this year.
Thereafter, it will start shrinking going forward. In sharp contrast, EM consumption will rise by 7.8M bpd between 2022-2028.
3. India to surpass China by 2027: Although both countries will continue to see demand increase, India will surpass China as the main source of growth by 2027.
4. Non-OPEC+ will be the primary source of growth in oil production: Production growth from OPEC+ will remain intact, while non-OPEC+ countries will be driving production growth.
PART 2: CRUDE OIL DERIVATIVES
CME offers a variety of instruments for producers, consumers, and investors to participate in the crude oil market. This includes WTI Futures & Options and Brent Futures & Options. Beyond these, CME also operates markets in a range of refined oil products, fuel oil, and natural gas.
In a previous paper, we highlighted the 40-year history of CME Group’s WTI crude oil derivatives. With an extensive suite of derivatives on offer, CME Group enables multiple alternatives for different market participants.
Futures
WTI Crude is a widely used global benchmark for oil prices. It is the underlying for one of the most liquid futures contracts in the world – the CME Crude Oil Futures ("CL Futures"). CL Futures is a physically delivered contract with tight correlation to the physical oil market.
Over one million contracts change hands daily, representing USD 7+ billion in notional value. Each lot of the CL Futures contract represents one thousand barrels of crude oil. CL Futures provide deep liquidity and high-quality market structure for hedgers and investors to participate in and protect against oil price volatility.
Monthly contracts are available over the next ten calendar years. Front month contracts are easily tradable on CME Globex electronic order book. Longer dated contracts require engagement with inter dealer brokers for price discovery and voice-based trade execution.
Alternatively, CME’s Micro Crude Oil contract (MCL) offers exposure to just 100 barrels with a maintenance margin of just USD 580 (as of 23rd June), enabling affordable participation into these markets. The micro contracts allow hedgers to manage risk exposure with greater precision.
Options
Monthly options are available on the underlying CL futures. They are deeply liquid with seamless order book-based trading on CME Globex.
Open interest on the front month contract is >300,000 lots, representing premium of more than USD 1 Billion across calls and puts. More than 20,000 contracts are traded daily.
Weekly options are used to fine-tune exposure around key events such as OPEC+ meetings and interest rate announcements. Daily options are available for CL Futures. Monthly and weekly options are also available on Micro Crude Futures.
CME provides calendar spread options and mid-curve options which can be used as tactical trading and hedging tools given the seasonality of oil markets.
Trading Strategies
There are innumerable ways of trading the crude oil market. Most popular among them include (a) taking directional position using futures and options, (b) establishing shrewd hedges or convex trading strategies using options, and (c) trading delta-neutral calendar spreads gaining from relative shifts across the futures term structure.
Previously we have covered different trading ideas in crude oil, including taking a directional position - (a) Is US Oil running low on energy? (b) Is WTI crude set to rebound? (c) Three headwinds to send crude oil into free fall, (d) Harnessing gains from mean reversion in crude oil markets, and (e) Rebounding air travel & rising China to fire up WTI crude.
In our next paper, we describe the mechanics involved and illustrate the workings of popular trading strategies.
KEY TAKEAWAYS
In conclusion,
1. The Crude oil market is at the cusp of substantial change as energy transition powers on.
2. Change will be a constant. Impact on price will be anything but a straight line, creating both risks for the uninitiated and opportunities for the astute.
3. CME Group’s deeply liquid market with broad range of instruments enables market participants to harvest gains in risk-mitigated ways and to lock in credible reward to risk ratios.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Midway through 2023, crude oil demand appears wobbly on recession overhang and shaky economic recovery in China. Meanwhile, crude supply remains tight with OPEC+ scaling back production which has been compounded by limited investment in new exploration.
Over the long term, energy transition is set to fundamentally change the oil market. Consumers are shifting to EVs and renewable energy. In a befitting response, producers are reducing supply.
Energy transition will be anything but a straight line. It will create many risks and present many more opportunities.
This paper is set in two parts. First, we highlight key takeaways from a recent IEA report on crude oil outlook until 2028. Second, we explore hedging & trading instruments on the CME Group for participating in oil markets.
PART 1: KEY TAKEAWAYS FROM IEA CRUDE OIL OUTLOOK REPORT
The International Energy Agency (IEA) released Oil 2023 last week. This report describes in detail the changing dynamics in the oil market until 2028. It discusses key trends such as slowing demand growth, shifting producer growth, and the impact of energy transition on oil.
Recent crises have accelerated the energy transition. With COVID-19 plus rattled geopolitics, nations are increasingly more focused than ever on energy security and independence.
Ten key takeaways from Oil 2023:
1. Global oil demand to rise by 6% or 5.9M bpd between 2022 to 2028, reaching 105.7M bpd. Despite this, emissions will fall 11% with efficiency improvements.
2. Annual demand growth is expected to slow sharply in the coming years from +2.4M bpd in 2022 to just +400K bpd in 2028.
3. India and China will drive demand over the next decade while consumption among OECD countries will shrink.
4. Oil demand for gasoline will peak this year and start to reverse going forward with accelerated EV transition. Demand for transport fuels is expected to peak in 2026.
5. Jet fuel demand is still lagging 2019 levels by 13% and is expected to rise rapidly but only surpass pre-COVID levels in 2027 with expected efficiency improvements.
6. The petrochemical sector will replace the demand for transport fuels. Demand from LPG, Ethane, and Naphtha will increase by 40% from now until 2028.
7. Production growth from shale is expected to slow due to rising costs and lower prices. US shale will mature to a higher-return-lower-growth trajectory.
8. Global upstream oil and gas investment is projected to increase by 11% year-on-year in 2023, reaching USD 528 billion. This represents a rise from USD 474 billion in 2022.
9. Non-OPEC+ countries, including the United States, Brazil, and Guyana, will lead the medium-term capacity expansion plans. They are expected to contribute to a supply boost of 5.1M bpd.
10. By 2028, an additional 5.9M bpd of net production capacity will come online. The rate of new capacity building will decrease over time, aligning with projected demand growth.
Following four charts help visualise the large shifts underway in the crude oil market:
1. Price Sensitivity to Imbalance: Crude oil prices are highly sensitive to imbalances between production and consumption. Over the past 25 years, consumption has been marginally higher than production. Where deficit rises, spot prices rally.
2. Consumption between developed markets (DM) and emerging markets (EM): Consumption in EM will further outpace OECD countries. Consumption across EM overtook OECD in 2013 and this trend will be further entrenched. IEA forecasts that consumption in OECD countries will hit its apex this year.
Thereafter, it will start shrinking going forward. In sharp contrast, EM consumption will rise by 7.8M bpd between 2022-2028.
3. India to surpass China by 2027: Although both countries will continue to see demand increase, India will surpass China as the main source of growth by 2027.
4. Non-OPEC+ will be the primary source of growth in oil production: Production growth from OPEC+ will remain intact, while non-OPEC+ countries will be driving production growth.
PART 2: CRUDE OIL DERIVATIVES
CME offers a variety of instruments for producers, consumers, and investors to participate in the crude oil market. This includes WTI Futures & Options and Brent Futures & Options. Beyond these, CME also operates markets in a range of refined oil products, fuel oil, and natural gas.
In a previous paper, we highlighted the 40-year history of CME Group’s WTI crude oil derivatives. With an extensive suite of derivatives on offer, CME Group enables multiple alternatives for different market participants.
Futures
WTI Crude is a widely used global benchmark for oil prices. It is the underlying for one of the most liquid futures contracts in the world – the CME Crude Oil Futures ("CL Futures"). CL Futures is a physically delivered contract with tight correlation to the physical oil market.
Over one million contracts change hands daily, representing USD 7+ billion in notional value. Each lot of the CL Futures contract represents one thousand barrels of crude oil. CL Futures provide deep liquidity and high-quality market structure for hedgers and investors to participate in and protect against oil price volatility.
Monthly contracts are available over the next ten calendar years. Front month contracts are easily tradable on CME Globex electronic order book. Longer dated contracts require engagement with inter dealer brokers for price discovery and voice-based trade execution.
Alternatively, CME’s Micro Crude Oil contract (MCL) offers exposure to just 100 barrels with a maintenance margin of just USD 580 (as of 23rd June), enabling affordable participation into these markets. The micro contracts allow hedgers to manage risk exposure with greater precision.
Options
Monthly options are available on the underlying CL futures. They are deeply liquid with seamless order book-based trading on CME Globex.
Open interest on the front month contract is >300,000 lots, representing premium of more than USD 1 Billion across calls and puts. More than 20,000 contracts are traded daily.
Weekly options are used to fine-tune exposure around key events such as OPEC+ meetings and interest rate announcements. Daily options are available for CL Futures. Monthly and weekly options are also available on Micro Crude Futures.
CME provides calendar spread options and mid-curve options which can be used as tactical trading and hedging tools given the seasonality of oil markets.
Trading Strategies
There are innumerable ways of trading the crude oil market. Most popular among them include (a) taking directional position using futures and options, (b) establishing shrewd hedges or convex trading strategies using options, and (c) trading delta-neutral calendar spreads gaining from relative shifts across the futures term structure.
Previously we have covered different trading ideas in crude oil, including taking a directional position - (a) Is US Oil running low on energy? (b) Is WTI crude set to rebound? (c) Three headwinds to send crude oil into free fall, (d) Harnessing gains from mean reversion in crude oil markets, and (e) Rebounding air travel & rising China to fire up WTI crude.
In our next paper, we describe the mechanics involved and illustrate the workings of popular trading strategies.
KEY TAKEAWAYS
In conclusion,
1. The Crude oil market is at the cusp of substantial change as energy transition powers on.
2. Change will be a constant. Impact on price will be anything but a straight line, creating both risks for the uninitiated and opportunities for the astute.
3. CME Group’s deeply liquid market with broad range of instruments enables market participants to harvest gains in risk-mitigated ways and to lock in credible reward to risk ratios.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Full Disclaimer - linktr.ee/mintfinance
