Energy Markets

Markets- A
consultant’s perspective
p p
Presented by : Mr. Biren Vakil
CEO Paradigm commodity
Advisors Pvt Ltd
Ltd, Ahmedabad
 Market structure
Market structure
• Oil
Oil market constitutes of consumers, producers, hedge funds, speculators, 
market constitutes of consumers, producers, hedge funds, speculators,
traders, brokers, financers, venture capitalists, investors, specialty funds 
like enhanced Alpha and Beta specialty funds, retail investors and many 
more.
• For the economy ‐it is life blood of economic activity, for the industry it is 
a source of creamy profits and for investors and speculators it is an 
important asset class and store of value
important asset class and store of value.
• Oil presents different kind of opportunities for different kind of people 
and entities. It s attracting all kind of money– smart money, hot money, 
di
dirty money and good money. In African and former CIS‐
d d I Af i df CIS it’s a black 
i ’ bl k
capital for rogue regimes and for mafias. Due to its strategic importance 
corruption and oil and gas trade are inseparable. 
• Oil Market is defined into futures market, physical market and structured 
OTC product market and is very opaque in nature.
 Emergence of Alternative investment markets
Emergence of Alternative investment markets

• Emergence of alternative investment markets like ETF, ETN, beta specialty 
funds, enhance Alfa funds are agent of change in market structure . 
Innovation in financial products above normal risk appetite and row
Innovation in financial products, above normal risk appetite and row 
money power has dwarfed consumer and producer as a price setter.  With 
the help of carry trade‐ ultra cheap financing, speculators have hijacked 
thi
this market. Commodity futures trade alone has grown from $ 180 bln
k t C dit f t t d l h f $ 180 bl in i
2002 to 3 trillion in 2009. Global ETF industry has grown to 1.1 trillion and 
oil and gas ETF investment size is nearly $ 150 billion. 

• Growth of Gas ETF market has caused some market turbulence in US last 
year and ETF industry can prove financial time bomb For example‐ SPDR 
year and ETF industry can prove financial time bomb. For example‐ SPDR
gold trust ETF holds 1300 ton gold. – World six largest gold holder. If US 
Govt order to close this fund‐ Gold could halve its value.
 Exchange Traded Fund (ETF)
Exchange Traded Fund (ETF)
• An to track the movements of light,
light sweet crude oil (("West
West Texas Intermediate
Intermediate")). USO
issues units that may be purchased and sold on the NYSE Arca.
•Currently the ETF industry consist of USD 1.1 trillion.
•The oil & gas ETF size is USD 128 billion. exchange‐traded fund (ETF), also known as an
exchange‐traded product (ETP), are essentially Index Funds that are listed and traded
on exchanges like stocks.
ETF have opened a whole new panorama of investment opportunities to Retail as well
as Institutional Money Managers. They enable investors to gain broad exposure to
entire stock and commodity markets in different Countries and specific sectors with
relative ease, on a real‐time basis and at a lower cost than many other forms of
investing. It as a Mutual Fund that you can buy and sell in real‐time at a price that
changes
g throughout
g the day.
y
•Example: The United States Oil Fund, LP ("USO") is a domestic exchange traded
security designed

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 Index Funds
Index Funds
• A type off mutuall fund
f d with h a portfolio
f l constructed
d to match
h or trackk the
h
components of a market index, such as the Standard & Poor's 500 Index
(S&P 500). Goldman Sach, Dow Jones AIG, CRB, Rogers International are
popular index funds. Goldman Sachs is energy centric fund while CRB and
Rogers international are more balanced funds.
• An index mutual fund is said to provide broad market exposure,
exposure low
operating expenses and low portfolio turnover.
• Investing in an index fund is a form of passive investing. The primary
advantage
d to such
h a strategy isi the
h lower
l management expense ratio i on
an index fund. Technically speaking‐ index funds are long only funds‐ i.e.
these funds always buy an asset. They cannot short an asset. Hedge funds
can buy or short sell the asset.

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 Leading Oil Markets
Leading Oil Markets
• NYMEX is largest exchange and widely watched as a benchmark 
l h d d l h d b h k

• ICE is second largest and TOCOM is third largest.
ICE is second largest and TOCOM is third largest

• MCX – the Indian Energy Exchange has overtook TOCOM in Gas trading 
and is third largest  Gas trading exchange in the world. MCX terminals are 
now present in far flung in the country and anybody can trade  oil and gas 
on MCX. These contracts are mirror image of NY contracts.
g

• Singapore is the hub of physical oil market. Besides Platt's oil gram‐ a 
company promoted by McGraw‐Hill is offering hedging platform. Another 
db M G Hill i ff i h d i l f A h
such price facilitator is Argus. Both these companies are useful service 
providers for OSP benchmarking to make long term contracts.
 Key drivers of Oil and Gas Pricing
Key drivers of Oil and Gas Pricing
• Growth
G th ‐ GDP • W
Weather
th shocks
h k
• Income • Forward curve’s shape
• Price elasticity of demand • Size of speculative positions in
• Price elasticity of supply the futures market
• Role of reserves • Trader’s sentiments
• OPEC behavior • Flow of funds in and out of
• Spare Capacity market
• Noise Traders • Exchange Rate fluctuations
• Inventories • Refinery
R fi shutdowns,
h td eventt risk
ik
• Wars & other Geopolitical • Energy security and resource
conditions hunt

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 The PLATTS MARKET‐ON‐CLOSE 
(MOC)
• A price‐discovery system designed to yield a price assessment reflective of
market values at the close of the typical trading day.

• The MOC pricing system recognizes as a core principle that price is a

function of time and MOC enables Platt to have full clarity on the price at
the close of business.

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• In a real‐life example, a gasoline seller might believe the market value of
gasoline to be high and a buyer might believe it to be low.low Let
Let’ss call the
seller X and the buyer Y.
• Platt seeks to gauge the true value of gasoline.
• In the MOC process,
process X might offer to sell at 154.25
154 25 cents per gallon (cts
/gal) and Y might bid to buy at 152.75 cts /gal.
• X and Y communicate their bids/offers to a Platt’s market editor.
Communication may be via an instant message to a Platt Platt’ss market
reporter, who inputs the information internally ,or via Platt’s electronic
window communication tool enabling market participants to input data
directly. In either instance, the information is delivered back to the
market
k t att large
l i reall time
in ti th
throughh the
th Platt's
Pl tt' Global
Gl b l Alert
Al t electronic
l t i
service.
• Platt at this stage can assess market value between 152.75 and 154.25 cts
/gal.
/gal
• X and Y can change the price at which they are bidding and offering by
small reasonable increments, and each of these price changes is published
on the real‐time screen as a pprice alert headline.
• As offers and bids become sharper, as in any negotiation, the strength of
each party will determine who acts first, both knowing that other market
participants could intervene with a bid or an offer.

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• X may gradually move its offer down to 153.00
153 00 cts /gal while Y does not
budge, and X may eventually sell at 152.75 cts /gal.
• This process gives a very detailed information trail to Platt's, and the
p
assessment derived from it is not an opinion that X is right
g or that Y is
right, but a reflection of the fact that either party would be expected to
complete a transaction if its counterparty or another market participant
met a bid or an offer.
• It is possible
bl that
h both
b h parties may not traded at allll but
b only
l remain bidding
b dd
152.75 cts/gal and offering at 153.00 cts /gal, in which case the
assessment will consider the bid and offer in its assessment process and
an assessment will be made based on the factual market data.data
• It is important to note that Platts has very strict systems and disregards
market gapping activity in its assessments.
• If,
If for instance,
instance a market participant were to want to overpay or undersell,
undersell
by lifting high and unreasonable offers or selling into low and
unreasonable bids, such activity would be disregarded. In these cases, the
transactions would be ignored and the assessment would take into
account theh last
l relevant
l bid and
d offer,
ff with
i h an editorial
di i l assessment made d
of value, but the last trade would not be considered to be of value.

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 Pricing Argus North Sea Dated
Pricing ‐ Argus North Sea Dated
• Argus uses market’s implied value for the North Sea Dated price reference
obtained by cross referencing forward trade, CFD trade and physical
differentials for the four BFOE crudes within the 10 10‐21
21 day assessment
period.
• The building block from which the North Sea Dated assessment is derived
is called the “flat” p
price or “forward” p
price. It is the p
price for Brent crude
for loading in one (or possibly two) months time.
• Argus assess prices for 12 pipelines crude markets, based on a
methodology that includes deals done through out the entire trading day.
• It trades on a barrel per‐day basis because oil moves all day, everyday.
This is why the logic of the market‐on‐close window methodology
escapes most producers and refiners, and why so many of them now rely
on Argus for their crude indexation requirements.
requirements

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 The path ahead
ahead- Volatility is a way of Life

• Energy markets becoming increasingly volatile due to

ultra loose monitory policy and expansive fiscal policies.
As real interest rates are sharply negative,
negative investors and
money managers are chasing oil and commodities in
search of higher
g returns.
• Sovereign debt crisis of Europe and Debt monetization
by US, UK and Japan is also encouraging capital flows
into resources. The liquidity overhang has an era of
Dynamic Dislocation. Hence, price overshooting or
undershooting
d h ti would
ld become
b a rule
l rather
th th
than an
exception. Volatility is here to stay and industry has to
cope it.
it
 Market Anomalies
• Ph
Phenomenall rise
i off alternative
lt ti investment
i t t
markets (AIM) i.e., hedge funds, ETFs and
Index Funds are new kids on the block.
• Normally,
y, p
price setters can be either a
producer or a consumer, but as resources
are
a e nowo financial
a c a cocommodities,
od t es, p price
ce
setters are banks and speculators.
• OPEC is dwarfed by AIM. AIM This is new
normal.
 Oil forecasting-
f ti A ttricky
i k business
b i
• A
Arjun
j M th off Goldman
Murthy G ld S h made
Sachs d oilil forecasting
f ti a
tricky job, good for consultants, bad for banks/hedgers
and uglyg y for the industryy which is not interested in short
term price volatility but interested in long term
investments and build business.)
• During
D i l t 2 year oilil has
last h f ll
fallen f
from 145 to t 35 and d
bounced back to 85. Robust demand from Asia and
emerging
e e g g eco
economies
o es aand d de
demand
a d des
destruction
uc o in O OECD
C
are counter cyclical forces and act as a tug of war.
• Macro demand trend suggests long term trend is up, but
i the
in th mediumdi t
term price
i may trade
t d between
b t $ 60-
60 $ 90
 Continued..
Continued
• There is no fundamental or technical
y within a $60-$80
reason that oil stays
band. But that way Wall Street can’t make
money.
money
• Emergence of Algo Trading, hunger for
super normal profits
f and availability off
ultra leverage
g trading
g tools p propels
p
volatility.
 Continued..
Continued
• E
Energy projects
j t are build
b ild up with
ith 20 – 50
years of horizon, but volatility has reduced
planning, management and financing into
diserror.
• Herd forecasting by consultants has added
oes a
woes andd co
conflicting
ct g ttheories
eo es likee Supe
Super
Spike Theory by Goldman Sachs (2005)
and Mega Bear Theory from Deutsche
Bank (2008) just confused market
Gas – No guess is the best guess!!
• Gas remains nasty and sexy commodity - nasty
for unsuccessful and sexy for successful.
• During last 20 years, it often spiked from $2 to
$15.
• Since weather is key driver and advent of Gas
ETFs has changed the micro and macro
dynamics of trade and industry.
• Thanks to opacity,
opacity organized manipulation is the
name of the game in Gas futures market.
 Continued..
Continued
• St
Storage glut,
l t presence off Index
I d and
d Long
L only
l
funds ETFs, Option Trading and flowed carry
structure makes NYMEX Gas a unique
commodity.
• In last two years,
years Gas market offered super
normal arbitrage opportunity
• In 2008,
2008 prices plummeted to $2 and “carry”
carry co
tango soared to 100% annualized
• Gas also known as an Alpha commodity and
sometimes behaves inversely to the oil.
 The coming Gas Shock
• T
Talks
lk off Shale
Sh l technology,
t h l l
large untapped
t d
reserves and perceived supply glut suggest a
bear market in Gas, but futures market and rig
count points a different picture.
• Gas has strongly
g y outperformed Oil and storage g
build up shows extra supply is being eaten out.
• During 2005 peak of $12, rig count of Gas
reached to 2106,
2106 and now fallen to 800.
800
• This may lead to a supply shock if new
technology fails to deliver and post BP regulation
makes drilling less attractive
 Forecasting Techniques
• There are two basic schools – Qualitative and
Quantitative.
• Qualitative
Q lit ti approachh includes
i l d T h i l Analysis,
Technical A l i
Behavioral psychology, market research and Subjective
Thinking like fundamental analysis,
analysis gut feels,
feels logical
• Quantitative approach includes Statistics, generic
algorithms,
a go s, b
black
ac bo
box trading
ad g aand
d au
automated
o a ed sys
systems.
e s
• Another late emergent is mix of both, using chaos and
viewless trading.
g We believe- a mix approach
pp and event
driven approach is good for long term success in
forecasting.
 Energy forecasting-
forecasting A Paradox
• It is
i Irony
I th t forecasting
that f ti h dl works
hardly k whenh it is
i
necessary and when it works it is hardly a necessity.
• Hear mentality is the major forecasting pitfall.
pitfall In 2009 oil
hit 145 and everybody was talking 200 but it fell to 35.
When It fell below 50, forecaster started calling for 30 or
even lower.
l S h kind
Such ki d off herd
h d mentality
t lit damages
d l
long
term planning, market efficiency and had not benefited
people
peop eaat large.
a ge
 Price Outlook
• Oil & Gas production cost varies from country to
country and operator to operator.
• However, path of least resistance is seen to the
upside due to robust consumption in Asia, Aging
g g
infrastructure & underinvestment in Europe, and
probable peak in US & Europe may lead to a
supply shock when Global recession is over.
• We believe NY WTI Oil may hit $100 - $120 and
Gas may hit $10 in 2011-2013.
• THANK YOU