Commodity Research Group (CRG) is an independent research consultancy specializing in base and precious metals, as well energy products. The Group provides research and general price analysis for these markets, along with advice to companies seeking to construct hedging strategies.
In this podcast, oil market experts Andrew Lebow and Jim Colburn discuss key fundamental forces driving oil prices in both the futures and options markets.
About Your Hosts
Andrew Lebow has been involved in the energy derivative area since 1980. He began his career with Shearson Lehman Brothers where he worked in the initial formulation and marketing of the NYMEX WTI crude contract in 1983 as well as the NYMEX gasoline contract in 1985.
Mr. Lebow has appeared before the State Government of Alaska as well as the State Department of Defense to discuss hedging techniques. Mr. Lebow is also well known as a market analyst and is quoted frequently in the financial press. He has appeared on television on CNBC, NBC, CNN, CBS, and PBS. Mr. Lebow holds a BA from Lafayette College and an MBA from the Kellogg School of Management at Northwestern University
Jim Colburn is a futures and options professional with 30 years of wide ranging experience in commodity markets. For much of his career, at Man Financial (1989-2011) and Jefferies LLC (2012-2013), Mr. Colburn worked with major integrated oil companies, hedge funds, pension funds and other entities to develop market hedging and trading strategies.
He has conducted trading, hedging and risk management workshops in energy markets worldwide.
Mr. Colburn is a published author on options trading, hedging, market making and risk management. In 1986, while at the New York Mercantile Exchange, Mr. Colburn helped develop new markets in energy option contracts by educating the oil industry, banks, floor traders and brokers, worldwide.
Good morning. This is Jim Colburn of commodity research group. I’m with Andy Lebow also of commodity research group and we’re here to talk about energy markets. Check out our website, commodity research group.com where we post our blog and our podcast. It’s under reconstruction right now so you can still get on it, but it’ll be ready in just a couple of days. We’d like to thank our friends at EKT interactive oil and oil and gas training for hosting this podcast. You can check out their podcast and learning firstname.lastname@example.org this podcast should be construed as market commentary, merely observing economic, political and market conditions and is not intended to refer or endorse any particular trading system, strategy or recommendation. We are not responsible for trading decisions taken by anyone, especially those not intended to listen. Information is not guaranteed to be accurate. This is not an offer to buy or sell any derivative. Today is December 12th. Good morning and he looked both. Good morning, Jim Colburn. Uh, we have another momentous, a OPEC meeting last week and, uh, let’s, let’s get right into this. I mean we, we saw the one point to cut from OPEC, non-OPEC. I want to get your take on maybe a what happened but more along the lines of what we see is that in the market reaction to this.
Okay. Well first of all, uh, what happened, I think that OPEC realize that, that they had to give the market some, some type of an agreement. Uh, they couldn’t walk out of, they couldn’t walk away with, with, uh, with no agreement. I think given what’s happened in the market during October and November, it was pretty clear that they had to come up with a, you know, some, some coach and agreement. I think they did a, the headline dues was the headline was that OPEC was gonna cut 800,000 and non OPEC was going to cut 400,000. And you know, as, as well as I’ll talk about those are just the headline numbers. I think a reality, the cuts are going to be deeper than that. But you know, overall I think they did a given, uh, all the, the cross currents in Opec, uh, visa vi, the Iranians, Iraqis, the Saudis and the Russians, I think that they came up with a pretty good agreement gym,
but the market is not flying up. It’s kind of shop. I mean it’s, I guess it’s a, it’s a victory. It stopped going down, right? It stopped going down. Well, that’s a start. Yes. So what’s, what’s the market saying from the, what do you think is going on?
Well, let’s let, let’s talk about w w what happened and really, really what happened, you know, for all the talk about, um, demand being crushed, which so far it hasn’t been, but it’s really been a, been a supply situation. We saw Saudi alone from, from June to November, go up a million barrels a day. We saw the u s from June to November go up a million barrels a day. We saw the Russians go up a half a million, you know, roughly half a million barrels a day. So, you know, we’ve seen a tremendous onslaught of, uh, of supply. And while demand I think has been demand, some pretty good gym, uh, it’s just hasn’t been, it hasn’t been enough to absorb all that, to absorb the, uh, the added supply. Um, and as a result in, in the third quarter and into the fourth quarter, we’ve seen a real imbalance on, uh, uh, a real surplus in the market. And in third quarter, uh, we probably grew inventories, you know, somewhere like 300,000 to half a million barrels a day. And then in the fourth quarter, owing to the Saudi’s big boost in November, we probably are going to build something like 700,000 barrels a day. So, so all of a sudden, you know, there’s a lot of inventory on the market. And
for a year we were talking about how tight it was going to be in the fourth quarter
and it, and it was just the opposite happens. Yeah, it happens so often, you know, we were saying, well, this is the gym. I think you said it every monthly, you know, this, everyone’s a, you know, this is, this is the most wealth forecast. Fourth quarter. Draw your though ever so often happens. Whatever you want us to look at it. The same thing. You know, we’re all, we’re all wrong. Hey, I was looking for a draw too, but you know, I never, again, I didn’t expect the Saudis would be up at 11 one and the in November. And part of that is political, uh, to make, to make room for what we thought was going to be a, uh, you know, a, an Iranian shortfall, uh, with the, with the waivers coming in, uh, in November. And of course those waivers, the waivers, the sanction starting in November. And of course there are waivers given to the sanction. So Saudis way over it. Did it weigh on? Yeah.
You know, Andy, I’m looking at the OPEC production from today’s, um, uh, OPEC report and their show, they show Iran, uh, for November down to a two, 2.95, four down three 88, right. This, this, this is based on the secondary sources. Yup. And Saudis at 11.0 up three 77 so they’re kind of, you know, a mirror mirror image of each other. But we were looking for more draws may mean a bigger decline in neurons production. Is that right?
I think we were looking for bigger, some bigger declines around is already down 800,000 and they’re going to lose, you know, even with the waivers, you know the, the, they’ll lose another, it could be as much as half a million barrels a day because the waivers only allow for, I think it’s about 1.2 or 1.3 million barrels a day of Iranian sales versus the 2.6 pre pre sanctions. So you know, Iran still has room to go down actually. Um, and I think in first quarter, uh, they are going to go down, you know, go down some go down another hundred or 200,000.
Just a little a sidetrack him. As I’m looking at this table, I see Venezuela is down 52,000 down to 1.137 that’s a, that’s just a credible, it keeps, it keeps going down.
Jim, this is nothing that is it the, that it’s not going to go down the stuffing
down a million barrels a day from 2016.
Right? Right. And they’re, they’re probably due to go down another, you know, 30 to 50 a day every month, you know, so by the end of that, by the end of the year, you know, they could be at half a million barrels a day production by the end of 2019. So that’s part of the story, right? That’s part of the story. You’re gonna get the facto cuts from Venezuela and also from, uh, uh, ran in 2019. You know, we know that, that they’re going to reopen the, um, the waiver situation and in April or May. So, um, you know, we aren’t, we’re going to get cuts from those two producers. We’re also going to get caught smartest cuts from the UAE and Kuwait, Iraq. I don’t think they’re going to cook very much that, that, you know, at best 50 to a hundred. And the Saudis said at the OPEC meeting, you know at, at the press conference that the, for January, they’re a 10.2, they went down 900,000 from November.
You’re right. And for about 400 from October. So that’s
right. Yeah. Those are actual cots. Yup. Um, so our numbers or you know, I have OPEC producing a 31 eight in the first quarter average for the first quarter down from 33.0 and in November. And that’s probably going to be around the fourth quarter average. So, you know, they’re saying 800 but you know, you throw in Iran and Venezuela and what Saudis already done and some, some modest cuts from some of the other producers. It’s more, it’s going to be like 1.2 wow. And now Libya is having, you know, this is a force for sure. Libya, that’s going to affect 400,000 a day. We don’t know how long that’s gonna last. But you know, you throw in that and you know, you’ve got some really significant OPEC production cuts plus non OPEC Canada, right? Canada 350 a day. And, uh, Russia is, you know, they said two, two 30, I think the number was two 80. Um, you know, it’s not going to be right away, but by the second quarter they’ll, they’ll have made some cots.
You’re saying this is enough to mop up the sort of the builds that we have going forward.
Well that, that’s the, that’s where, um, you know, when you do, when you do the barrel counting, which Jim as you know, we love to do it. It looks as though first quarter is going to be, you know, a surplus to a deficit. Either way, is it enough to going to mop up the near term surplus swell? Maybe not, not completely mop it up, but it, it, you know, it’ll definitely help. And of course if we get any type of a winter, you know, any type of wind, cold, cold weather demand, you know, it, it will help. And you throw in, if Livia is down 400 a day, you know, in the first quarter, yes, it is good to, you know, it will be mopped up.
Interesting. So, um, going back to the recent price decline, what, what you just said is it’s, it’s not just technical selling and it’s not out of the money options that were given up for dead coming back to life and market makers hedging them. It was real fundamental stuff that brought us, yeah.
Yeah. I think certainly the, um, you know, certainly the, the long liquidation contributed, uh, was it causal? It wasn’t causal, you know? Right. I think so we’ve been talking about the sweat our whole careers when they say, oh, well, you know, the speculators are good on the upside. Right, right. We’re not good on the outside, right there. Plane, they blamed, they blamed side. Right. For driving it. Hire people. Like maybe blame it, blame them too now for, for driving lower. But there has been, I mean, there was a remarkable liquidation of the speculative position
for sure. And I, and it’s a, I don’t want to immediate does, it’s hard to determine exactly the, the um, uh, how much the effect of, you know, there were a lot of deep out of the money options that, especially where the volume was on the put side and the market blew through them. So, you know, if you’re sitting there too long, those you don’t have to do anything. You don’t panic. You’re saying, Oh this is nice. You sit back and you wash your option, come back to life. And the people that are short, those have to either get out or they sell aggressively futures in front of the, you know, in front of the strike going into money. So, you know, people say, well that describes it lower and it does, but at some point the other side gets out. So it’s, you know, it balances out.
So if you, if you believe that’s what happened and I think it’s some of that drove it down. Then once those options go off the board or once you know at at some point the, these, the people who are wrong to put sell out and that should drive it the other way. We never got that. We never got that snap back after December. Options would often boards. So you know, these, you say there was something else going on in here and I think you just laid out that a lot of oil was thrown into the market. Right. As you know, the other thing there was pre-buying right. I think I’ll, I’ll fill, we’ve mentioned that in the press conference that it’s definitely, if, if anybody want, one thing that I think will be very instructive for anyone who follows these markets is to watch the OPEC, the POSTDOC OPEC press conference with a awfully and Alexander Novak, the Russian oil minister.
I mean they give you a lot of information. It was great. Really enjoyed listening to that years there was real, you know, they just told you, you know, there was, it just gave it, you know, there was a lot of black and white to a what [inaudible] was saying. And also, and also what Novak was saying, one going just talking about this log liquidation. I do have a great statue. Yes. On October 2nd, the net length of Spec of the money managers, if you added Wti and Brent together, right, was 800,000 contracts. Wow. All right. On December 4th, it was down to 265,000 contracts. That’s amazing. It’s amazing. We had over 500,000 net length was, I mean it shows you that inherent bias there. I mean, maybe it’s these long only strategies, but what does it take to turn it around to get, to turn it to short, short, because of that bias, right?
There’s a, there’s, there’s a, you know, if you have a commodity, uh, like a long only strategy in commodities, it’s a small part of your portfolio. And as these prices go down, it’s an even smaller part of your portfolio. So if you’re trying to stay balanced, you actually are a buyer of commodities on the way down. If, if your committee or your meetings or your strategy is, you know, let’s say you’re staying 5% in commodities and now all of a sudden your four, 3% in your, then you’re a buyer. Now that’s oftentimes it happens that the, you know, the, the institution will say, well, we want to get out of commodities. Well then, then they’re liquidating a position. But normally when you decide 5%, you keep it at 5%. So, so there’s always that, you know, you can see why there might be always aligned position in the marketplace.
There’s always some, uh, somebody’s trying to put it into the portfolio is a small part and it’s not like futures traders who are, who are buying under, um, you know, leverage conditions and it, at some point you have to just kick out of the position. It’s a little different. I don’t know if you wanted to mention, uh, it’s, it’s more natural gas related, but the options sellers dotcoms story that came out or this a company that based on their name, they were selling options and, and uh, the natural gas move, um, um, blew them out of the water and it was just, uh, you know, uh, I don’t know how, I don’t know how that happens. And after all these years and you know, we know these commodity markets make these kinds of moves. They made oil’s going down and natural gas is going up in a, in a sharp way and, and uh, I don’t know, you, you can make money selling options for, for a while, but then you have to, uh, you end up paying the piper.
Yeah, it’s true. It’s true. It’s really a, a, a unbelievable story that unfortunately, it’s believable because we’ve seen it again, again and again serving. And I feel like, uh, I haven’t done enough work educating, you know, getting out there and you just, it just doesn’t long run. That’s just a strategy that doesn’t work. You know, Jim, you pointed out that there was a hedge fund, um, one of the best performing hedge funds this year. And what was their strategy? They were buying options, you know, they’ve been doing it for like 10 years, right. And longevity. And they were able to capture, and I think, I know that’s something that you, you said again and again, you know, that you way prefer buying options then that’s, that’s my bias. I’m not saying you never sell options. Oh no, of course not. As a blended strategy. You know, there’s a long only strategy is a short option strategy and that kind of thing.
We do it all the time. So November 23rd, we reached a high involatility of 58.3. That’s a pretty high number. That was higher than the OPEC meeting we had in November two years ago and his November two years ago. Uh, but it wasn’t as high as the price low we made in February of 2016. Um, that got up to close to 80. I believe. I still check that. Uh, I think that’s right. Yeah. So this is, uh, you know, it’s a tendency of oil, uh, when prices are going down, files blow out and um, contrarily natural gas, November 19th, uh, reached a revolver of one 18.9. So that’s, that’s like a Gulf War one type for oil type volatility. I mean that’s pretty, that’s pretty massive. And I again, that’s somebody at least, at least one company blew out of a position. So maybe that’s what it was. You had huge price move plus, you know, people scrambling out positions helps drive that thing up there. And I’m currently, we’re at 39, four for, uh, it’s as, as it yesterday settlement for crude oil and 89.5 for natural gas. And um, that’s where we are.
Jim, how did you just do that? You know, while you were talking about volatility spiking, there was a siren going off in your, uh, is your neighborhood. Yeah, there was a, it was very, that was very well done because I thought, all right. Yeah, that’s right. When viles of drawing files is spiking though 118, you know, that’s a massive site.
Oh, I know. Andy has, you know, we do this, I do this from my home. And uh, I’ve tried all different kinds of hours and we have leaf blowers, kinds of edge, had to keep the sound down.
But it wasn’t me. It was so well timed, perfectly timed that that truck went by.
I posted something in, in my linkedin page about the, and, and on the blog about the natural gas vol. And I just, I just learned, you know, I used to work at the exchange in 1986 when I rolled out the, uh, the new crude oil option. And my job was to teach everybody, uh, you know, floor people that weren’t trading options, banks, brokers, and of course oil companies, you know, the fundamentals of, of options. And I learned so much, I mean, I, I felt in any way, but I learned so much from the market makers on the floor, you know, all the Chicago, a trading companies about risk and, and you know, you just never lay so much, uh, of your position in a short vowel situation. It’s you, you, you just did to expose. In fact, there was a, there was a w a guy on the floor is the first day trading. He was staying within his, uh, Delta parameters in terms of being close to zero, but he got gamma exposed and they fired him after, after the first day because they trained them to stay with anyway, I won’t have to take a look.
Yeah, yeah. Why don’t you explain briefly to those who may not know anything. They are not savvy and options. So what does that mean? Gamma exposed? What happened?
This is it. I was talking about these options that go in. The money was that were out of the money. When you get close to expiration, they’ve given up for dead. They start to disappear. So their risk parameters that Delta is, how much is that option premium going to move when the Mousse and the gamma is? How much is that Delta gonna move when the futures move? So, so for example, you have a, uh, a $55 put in. The market’s at 60, and you’re expiring today. That thing the is close to zero. The GAM is close to zero. But as the market trades down from 55 to 50 now that puts about to go into money and have like an afterlife as a futures contract. Well, the futures contract has a Delta Won. And if the, if the option expires worthless as a delta of zero.
So once you start crossing over that strike going back and forth, you’re flipping from zero to one and back to zero and that that’s when your gamma is maximum, right? So you’re, so you’re changing. Delta’s happening so fast. So that’s, that’s kind of what they call a gamma rush as the gamma, or has prices collapse and these options, when the money, the person has long as that, who bought the option, as I said, it doesn’t have to really do anything because it’s going in their favor. But the person who is short, it has to cover the position either by selling futures, which is not a perfect cover or by buying the puts back. So that’s adds to the decline. And, and then if the market starts going up and they have to do the opposite, and then ads basically adds to the volatility that assumes nobody’s, you know, people and people on the other side are just sitting there and watching this thing.
So generally think we saw some gamma rush during October and November and the, uh, petroleum markets. I do. I think we did. We did. But, but it adds, you have to have, um, sort of a stimulus. I mean, I think it’s, it’s more like the, the dog. I mean, the tail wagging the dog, the dog is, you know, the fundamentals have to kind of support this in, to get it down to those levels and then it kind of catches fire. But, um, yeah, but it, it, it adds to the craziness. I think we saw some, as we said, that’s not causal, but it just added in there along with the long liquidation. Right. So, yeah. So November 13th, we had a record amount of volume options. Vine, it was like 600, almost 700,000 and it was, uh, about 451, 1000, 251,000 calls. So it’s kind of, and then in December was going off the board like the next day.
So, so it was a lot of, a lot of that going on. But again, if you’re not, if you’re not into someone’s, you know, there’s, there’s so many different people trading this market now, Andy and everyone has a different, is coming to it from a different angle and doing different things. And so they’re not always, you know, you say, wow, these are the market makers are doing this. Well maybe they are, maybe they aren’t. Right. Or I think maybe one of them is, or two of them are. But anyway, let’s go back a, I want to talk about, um, I don’t know, should I call it a tale of two products? Can we talk about that?
Yeah, we certainly can’t. US. You’ve been talking about this for a long time. You don’t wanna go back and find out exactly when, but how, how bad the gasoline market is relative to, to, um, the diesel market. Where do you, where do you want to start? I’m gonna Start with, I think that there, there could be some changes afoot in that. Uh, we didn’t see it this week in the Eia is last month the heat to gas, uh, the diesel to gasoline spread got out to 60 cents and the in November, I think, what’s the high diesel over over gasoline? I think it averaged 45 cents if I’m not, if not mistaken. Uh, which is a huge, I mean that’s a huge number. So certainly if you look at the cracks that they obviously favor the middle of this little cracks, which they have for a good part of the year going forward here over the next few months, you would think, and this is a seasonal, uh, you would think that refiners are going to try to maximize their yields of diesels to the best of diesel to the best of their ability.
And, um, at the same time, try to shave, shave gasoline yields. It’s easy for me to say. It’s a little harder to actually operational operationally do it depending on, um, depending on how you could tweak your refinery and tweak the, uh, tweak the crude run, you know, running certain yields through your, through your plant. But you know, maybe that is going to, to help to balance the gasoline to diesel. However, looking forward in the, in the short term, the 2019 and into 2020 and Jim will, we’ve talked about this already, but there’s a big change on the specs for bunker fuel. The Imo 2020 is what it’s called and we’ll talk about that more. So I think that it should help to boost overall global demand for diesel and, um, you know, overall gasoline demand that doesn’t look as if it’s a growing, it’s certainly not in the, uh, in the u s for diesel demand could, could grow next year.
But of course everybody knows this is coming. And, um, you know, refiners certainly know this is coming and are preparing for the change in Spec, which is effective in January of 2020. But I think, you know, and of course everyone’s saying how well diesel’s going to really be strong versus gasoline and uh, in 2019, you know, that’s, that’s a lock. And Jim, when they say they say it’s a lock here, really, you got to take a look. Yeah. Right. You really, you really have to a, you have to reassess. The other thing that should help gasoline obviously as the pump prices have come way off. And um, for the first time last week, I think they were, I think it was the first time this year they were below last year’s level, so, so that should help boost demand. The little demand’s been running what, a little bit below last year. Alibi. I mean, plus or minuses, it’s, the doe is looking for it to be unchanged. Last year. Diesel spin up 200,000 barrels a day versus last year. And you know, I think the doe, the IAA is looking for it to grow like a hundred next year in the, uh, in the u s
so, um, just a quick note, we will probably or hope to have some guests, uh, in the following in 2019 on our podcast. And, um, I think Andy, we should try to dig up a, um, a refinery person or like an either an economist or a trader that understands the refinery economics. We can dig into this, uh, you know, what’s, what’s going to happen with the diesel market going forward and are are the, uh, refiners prepared for it? I think they are, but
yeah, I think coming up next year we’re going to have a, uh, we are, we are scheduled to have a refinery, a refinery trader manager, you know, a, a hall of Famer only total hall of Famer to discuss, uh, downstream. And we’re also going to have a, a hall of Famer from Canada talk about what’s going on in the Canadian market. So we’ll, we’ll, we’ll look to do that in January or February.
Excellent. So terrific. That’s great. We will try to continue to do that. We need to get someone from a natural gas markets as well. So stay, stay tuned and we’ll see. Uh, we’ll, we’ll, uh, uh, unveil that as it happens. Um, it just, let’s, I want to get back to, um, finish up with the price forecast. Um, you know, we, the market’s come out of this OPEC meeting is pretty much, you know, it looks like it’s just chopping sideways, which is, I guess you mentioned before a victory, but, um, what do you, what do you think going forward, the, this market’s going to continue to go down or,
well, certainly, yeah, it could. A Bacon new law perhaps, you know, w I wouldn’t, wouldn’t shock me given what’s gone on and, uh, some of these other markets when this like one of these huge risk off move. So, you know, out of nowhere, not out of nowhere. I mean, there’s a lot of risk building team all around the globe. Uh, however, I think the fundamentals are, are, uh, much improved. I liked the market. I think that some point in January, February, particularly if there’s a, um, you know, if we, if we get a call winter, you know, if some of these, if we get a call, if we get a call winter, uh, and certainly if Olivia, if, if that’s, if that’s a longer term problem, you know, I think Wti is a chance to get up into the, you know, I think we could see 60 again sometime in January or February. If it’s a mild winter, maybe we may be, you know, maybe we’ll see mid fifties to 50, you know, 56, 58. So I liked the market. I think it’s, I think what OPEC did, particularly with the Saudis has been, um, undervalued by the, by the market.
You know, I think a lot of people are just saying, oh well it’s 0.8, well, you know, they’re caught all, it was only 0.8. It’s not enough, blah, blah, blah. In my opinion, it is enough, you know, cause it’s more than 0.8 and you and you’ve got to look, you know, you’ve got to actually, you got to look at with what OPEC production really is. You know, you know, where they, where they ended up, uh, in uh, in first quarter. And again as we’ve talked about on these, on these podcasts, the demand that the hand wringing on demand while Real, you know, so far the EIA and OPEC and their December reports have really not marked demand down for next year. Joe, I noticed that I was thinking what we’re expected to see some of that and there was nothing. Yeah. And later this week the IEA comes out, they may, they may lower it a little bit, but you know, what are we talking about a hundred a day, you know, we just lost 400 a day out of Olympia.
Okay, good. Okay. Um, anything else you want to mention? Andy just said there is something I want to mention that we are a lot of the, a lot of what we’re talking about a is available in our monthly report. And if you want a free copy, please feel free to reach out to to us. You can get me at a Lebow, a l e B o w d research group.com. Or um, Jim Colburn is Jay called Burn Col, B u r n a commodity research group.com. If you have any options, questions in particular, I think Jim gave a great discussion, um, gamut today. And you know, he has Jim’s written the book and this is one of the foremost experts on, uh, on energy options. Our website, as Jim mentioned, is under construction, but Jim, I think it should be built by when coming up. He’s still take a look at it, I think gives those stuff to see there. Yeah. So commodity research group.com.
All right. See you next month, Andy. Okay, great.