Big oil options trades revive speculation about producer hedging
Two big trades in oil options worth nearly $60 million last week boosted volatility in that market and revived speculation among traders that U.S. producers are placing hedges to guard against another price rout this fall.
Hedging for future production now is prudent, some said, as trading ahead looks to remain rangebound. However, dealers said bearish fears have been revived because supply is due to swell when refineries start fall maintenance just as a slug of imports is due to hit the U.S. Gulf Coast.
The two sizeable puts, equivalent to almost 1 million barrels of crude, expire in November next year and give the holder the right to sell at $53 per barrel if prices drop lower than that, according to data from the Depository Trust & Clearing Corp (DTCC).
The identity of the buyers was not known. Traders and bankers said the deals bore the hallmarks of Mexico's finance ministry and its national oil company Pemex. The Mexico hedging program is the most widely-watched operation by a nation in commodities markets.
Mexico's finance ministry declined to comment on the hedges.
After nearly two months of rangebound oil prices and lackluster trading, other drillers also have started to do more hedging, trying to lock in prices and protect revenue for output next year and even 2017, four sources familiar with the money flows said.
Hedging by oil producers increased in April due to a rebound in prices. It has picked up again recently, as drillers worry about bountiful supply in the third and fourth quarter.
Currently, benchmark prices of around $60 a barrel are down 40 percent from last June's highs. Hedging to guarantee a minimum price could also help producers safeguard access to lending when credit lines come up for review in the fall.
"Refinery turnarounds will cut U.S. runs and we have about four weeks until we switch to September trading," said John Saucer, vice president of research and analysis at Mobius Risk Group.
"Going forward, the window of opportunity may not be so robust, so producers now have to pick their positions."
Last week, Energen Corp said it began hedging its 2016 oil production, entering into swap contracts for some 1.1 million barrels at an average price of $63.80 per barrel.
MEXICO OR NOT?
Traders say the most recent big trades and the classification are similar to past transactions from Mexico's hedging program, which is designed to protect government finances from a drop in oil prices.
Some questioned if it was Mexico, noting the volume was much smaller than the typical multimillion-barrel trades under the sovereign deal.
Each tranche was for 470,000 barrels and was bought for a premium of $2 million, the data showed.
The timing is much earlier than usual.
FLURRY OF ACTIVITY
Even so, the flurry of recent forward activity has boosted implied volatility, a gauge of options prices, as well as liquidity in 2016 derivatives, traders said.
At-the-money implied volatility for December 2016 options has leaped to around 26 percent from 21 at the end of April, a sizeable jump that signals greater interest in the far-forward contracts.
Near-term volatility, meanwhile, has tumbled 16 percent since the end of April.
Options to sell contracts if prices fall below $55 and $60 per barrel by next December have seen a surge in open interest to records since the start of June.
March puts with a strike price of $55 per barrel are now some of the most liquid options with almost 13,000 lots of open interest. That is equivalent to 13 million barrels and follows a sudden jump of more than 10,000 lots in recent days.
The other big move was in June puts at $60 per barrel, which saw open interest hit records above 10,000 contracts.
According to Barclays research earlier this month, hedged volumes from high-yield exploration and production companies are 11 percentage points less for the following year than they were last year, and the lowest in the past eight years.
While U.S. refiners are currently producing at high levels for summer driving season, a large number are planning major maintenance starting as early as August and ending mid October.
Traders also point out that a glut of crude in the North Sea and West Africa is weighing on supply balances in the fourth quarter. This could bring additional supply in from offshore. [CRU/WAF]
Another incentive to hedge, analysts said, is that drillers are scheduled to meet in the fall with banks regarding credit.
Despite the bearish factors behind all the hedging, some traders said a slowdown in output or unexpected event overseas could still boost prices.