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Poster presented in the International Petroleum Week organised by the Energy Institute.

Poster presented in the International Petroleum Week organised by the Energy Institute.

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  • 1. International P Petroleum Week 15 – 17 Feb February 2010 Risk Adjusted Theo of Storage and ory the “Crude th “C d Oil Futures C F t Conundrum” d ” Jyoti Prasad Deka†, GradEI d Oil and Gas Consulting Mott MacDonald Limited g, g OBJECTIVE Notations To study the crude oil futures market based on commodity storage theory and F1t = Nearest front month (M) futures contract price at time tdraw conclusions by analysing the 1985-2009 data of NYMEX traded light crude 1985 2009 e F2t = Second nearest front month (M+1) f t S d tf t th (M 1) futures contract price at time t t t i t ti oil futures contract prices1, traders positions2 and US stock levels3. traders’ St = Spot Price t ti S t P i at time t THEORIES AND CONVENTIONS In = Crude oil inventory levels at time t The Th modern th d theory of commodity storage posits, i absence of stock-out f dit t i in b f k E (St+1) = Expected future spot price at t+1, at time t (note that there is no t+1 way to measure E(St+1); however in theory, E(St+1) establishes an risk at any time t, St < F1t < F2t < F3t …and so on; in order to compensate risk, t and t 1 t 1 equilibrium with F1t+1. inventory holders for their storage cost. y g Normal backwardation theory posits, at time t, F1t < E(St+1), F2t < E(St+2), yp ( t 1) ( t 2) Fig 1: Illustration of futures market mechanism …and so on; it describes futures market as a risk transfer mechanism where ‘speculators’ go long and earn a premium from hedgers for bearing future ‘ l t ’ l d i f h d f b i f t F1t+1 “Speculator may ‘roll into’ the F1 t price risk risk. next nearest front month GHR (2008) extend the storage theory to show that this risk premium (or F2 t {E(St+1)} ⇔F 1 t+1 F2t+1 t 1 contract” futures return) are determined by commodity’s inventory levels. Note that, both theories combined, futures market can be in ‘contango’ and {E(St+2 )} ⇔ F 2 t+1 ‘backwardation’ at the same time. It may lead to simple arbitrage of futures M1 M-1 M M+1 contracts and rolling returns without obligation of storage for delivery (Fig1) delivery. t t+1 t 1 t+2 t 2 METHODOLOGY I Excess futures return, ER = (F1t+1 - F2t)/ F2t I. E cess f t res ret rn Inventories: We de-trend the stock data1 (In) and record the ‘cyclic’ II. Spot Return, SR = (F1t+1 – F1t)/ F1t deviations about ‘normalised’ levels (‘N-In’). W th run a li d i ti b t‘ li d’ l l (‘N I ’) We then linear regression i (I – II) = Rolling return, RR on monthly dummies to investigate the seasonal variation of these deviations. deviations. (Fig 3.1 – 3.4) Fig 2: F1, F2, In/ ‘N-In’ (NYMEX traded and US data-1985:2009) N-In Futures returns: We investigate futures returns – spot, excess and rolling, and compare results with snapshots of ‘non-commercial4’ trading positions in n the light crude oil market at NYMEX. (Fig 4 1 – 4 2) NYMEX 4.1 4.2) F1 F2 In Causal relationship: Finally we develop a multivariate vector auto-regression auto regressionn ( (VAR) model on lagged variables of (In/N-In), returns ( ) gg ( ), (both taken as endogenous) and historic US treasury bill rates (taken as exogenous) and discuss its structural inferences. (Table 5.1 – Fig 5.2) RES SULTS Fig 3.1: In, 1985:2009 Fig 4.1 Distribution of ER, SR and RR, during 1985:2009 n Table 5.1 Granger Causality Test Null hypothesis: all lags of a particular Hodrick – endogenous variable can be excluded as d i bl b l d d Deviation D i ti Prescott trend ER SR explanator for the other. from trend filter Variables P-values P values Rejected? ∆ d SR d_SR 0.1223 0 1223 No Fig 3.2: ‘N-In’ Fig 3.3: In/‘N-In’ ∆In/N In ∆In/N-In 0.0052 0 0052 Yes RR Fig 5 2 Impulse R Fi 5.2 I l Response d_SR response to d_SR response to shock in d (In/N-In) d_(In/N In) shock in d SR d_SR Fig 4.2 ‘Non-commer rcial’ spread as a % of all open interest Fig 3.4: Seasonal Variation in ‘de-trended’ inventories N o n C o m m S p re a d a s % 35.00% o f a lll o p e n in tte r e s t 30.00% 2004 - 2009 8 4 P e rc e n t D e v ia t nP e rc e n t D e v ia t n 25.00% 5 00% tio tio 6 1985 - 2003 2004 - 2009 20.00% 4 2 15.00% 15 00% d_(In/N-In) response to 2 0 10.00% d_(In/N-In) response to shock in d_SR d SR shock in d_(In/N-In) _( ) 0 5.00% -2 2 -2 2 0.00% 0 00% J ul Nov J an J un M ar A pr Oct F eb A ug S ep 15 January 1986 15 January 1996 15 January 2006 M ay Jul Apr Aug M ar Jun Oct M ay Nov Jan Feb Sep CO C US O S CONCLUSIONS REFERENCES Crude oil inventories show a rising ‘trend’ in 2003-09, and are nearing the trend 2003 09, Accomazzo, D. & Frankfurter M. M. (2007). “Is Managed Futures an Asset Is levels of 1985-86 (Fig 3.2). Seasonal variations in stocks are more Class? The Search for the Beta of Commodity Futures - Working Paper”, prominent during 2004-2009 than previous years. (Fig 3.4) Cervino Capital Management LLC, California, United States. Rolling R lli returns on crude oil futures were found slightly l f k d il f f d li h l left-skewed.d Deaton, A & L D A. Laroque G. (1992) “On the B h i of C G (1992). “O h Behavior f Commodity P i di Prices,” ” However, However there is a strong upward surge of non commercial ‘spread’ non-commercial spread Review of Economic Studies 59: 1-23 1 23 during 2004-09 (‘spread’ is an extent to which non-commercial traders hold g ( p Gorton G. B., Hayashi F & Rouwenhorst K G (GHR 2008) “The G B F. K. G. (GHR, 2008). The equal ‘long’ and ‘short’ positions in futures contracts). (Fig 4.1- 4.2) Fundamentals of Commodity Futures Returns”, Yale ICF Working Paper y g p VAR results show causal and negative relationship between lags of No 07-08. Yale University, United States. inventories and returns on their current l i t i d t th i t levels. Th l Thus, GHR’ (2008) GHR’s assertion on stock levels and risk premium is found empirically sound sound. ACKNOWLEDGEMENT & CONTACT ( (Table 5.1 – Fig 5.2) g ) The conundrum: as discussed, inventories of crude oil have steadily built Author would like to thank Mr Azfar Shaukat, Director, Oil and Gas up since 2004 and non-commercial traders now hold more equal long and Consulting at Mott MacDonald Limited and colleagues for their support. short positions th any other ti h t iti than th time i th hi t in the history. F t Futures returns all thi t ll this † jyoti.deka@mottmac.com j ti d k @ tt while, while albeit volatile show little sustained growth or decline. volatile, decline Title image courtesy: www.flickr.com; www.liveoilprices.co.uk. 1,3 Published by the Energy Info ormation Administration, Department of Energy, United States. 2 Published by the US Commodity Futures Trading Commission. 4 Trading positions are classified as ‘commercial’ if traders use fu utures for hedging, otherwise they are ‘non-commercial’.