11/28/2020 Overview of Oil Trading

Overview of Oil Trading
-Sonal Gupta
11/28/2020 Overview of Oil trading
Agenda
 Introduction
 Fundamentals of Physical Trading
 Functioning of Energy Derivatives

Risk Management

Introduction – Setting the context
1
2 Fundamentals of physical Trading
Functioning of Derivative Markets 3
4 Risk Management
Overview of Oil trading

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What is Oil
• “Petroleum" = Latin words Petra, or rock, and oleum, oil.
• Largest Single Commodity in International Trade – Volume / Value
• Oil is found in reservoirs in sedimentary rock

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The Oil Story
• 1859 – Colonel Drake Strikes oil near Titusville, Pennsylvania

• 1870 – John d. Rockefeller started acquiring Kerosene refineries and strong position with railroad
to feed Europe/USSR. Formed Standard Oil Company
• 1879 – First crude oil trunkline called Tidewater was built, Standard oil acquired half of tidewater
and was busily laying pipelines to Buffalo, Philadelphia, Cleveland and New York
• 1880 – Oil was discovered near the Russian sea town of Baku. Over 20 refineries sprang up in the
region, but logistics was key; Enterprising Marcus Samuel developed the first organized Kerosene
shipping enterprise to compete with Rockfeller and send kerosene to Europe and Far east
• 1901 – Oil discoveries in Ohio, Oklahoma, Kansas, and the first true gusher at Spindletop, TX
flowed 110Kbd
• 1912 – Anti Trust litigation formed by energetic young president, Theodore Roosevelt, challenged
the Standard Oil Trust and Standard oil dissolved; Seven Sisters formed ( seven regional oil
companies – Exxon/ Mobil/BP/ Conocophilips/ Chevron/Texaco/Shell )
• Late 1940’s – Rise of Middle East Production with seven sister dominance
• Late 1950’s – Russia, significant player in Oil
• 1960 – Rise of new force -- OPEC
New Seven Sisters (Non OECD) – Saudi Aramco ( Saudi); JSC Gazprom (Russia);CNPC (China);NIOC ( Iran); PDVSA
( Venezuela); Petrobras ( Brazil) and Petronas ( Malaysia)

What do we need to know about oil?
What is Oil?
• It is a naturally occurring bituminous liquid composed of various organic
chemicals
• An “average” crude oil contains about 84% carbon, 14% hydrogen, 0.1 to 5%
percent sulphur and less than 1% each of nitrogen, oxygen, metals and salts.
What do we get from oil?

• High Speed Diesel (HSD)
• Motor Spirit (MS)
• Liquefied Petroleum Gas (LPG)
• Kerosene (SKO)
• Aviation Turbine Fuel (ATF)
• Furnace Oil (FO)
• Bitumen
• Naphtha
• Lubes
7
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The Oil and Gas Chain
Refining Process

World consumption patterns(mtoe)
World primary energy consumption grew by 2.5% in 2011, less than half the growth rate experienced in
2010 but close to the historical average. Oil remains the world's leading fuel, accounting for 33.1% of
global energy consumption, but this figure is the lowest share on record. Coal's market share of 30.3%
was the highest since 1969.
Source : BPSR
Proved oil reserves
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OPEC controls 73% (1196 mb) of the Global Oil Reserve
Source : BPSR
What next???????
The life of proven oil reserves is estimated to be 41 years
What then????

Organisation of Petroleum Exporting Countries ( OPEC)
 OPEC founded in Baghdad, Iraq, in September 1960
 To protest pressure by major oil companies (mostly
owned by U.S., British, and Dutch nationals) to
reduce oil prices and payments to producers
 Objective to unify and coordinate members'
petroleum policies.
 Original OPEC members include Iran, Iraq, Kuwait,
Saudi Arabia, and Venezuela
 OPEC members' national oil ministers meet regularly
to discuss prices and, since 1982, to set crude oil
production quotas.
 Between 1960 and 1975, the organization expanded
to include Qatar (1961), Indonesia (1962), Libya
(1962), the United Arab Emirates (1967), Algeria
(1969), and Nigeria (1971); Angola and
Eucador(2007). Indonesia suspended its membership
effective January 2009.
 EIA estimates that the current twelve OPEC members
account for about 40% of world oil production, and
about 2/3 of the world's proven oil reserves. Exports
55% of the oil traded internationally.
 Iran, Iraq, Kuwait, Saudi Arabia, Venezuela,
Qatar, Libya , the United Arab Emirates ,Algeria
,Nigeria ,Ecuador and Angola.

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OPEC Crude Production…

Global Oil Production by Area
Russia, Saudi Arabia
and US are top three
oil producers
World oil production increased by 1.1 million b/d in 2011,with OPEC (42%)accounting for nearly all
11/28/2020
of Overview of in
the increase despite a 1.2 million b/d reduction Oil Libyan
trading production.
Source : BPSR
Global Oil Consumption by Area
US; China and Japan
are top three oil
consumers
World oil consumption increased by roughly 600,000 b/d. All of the net growth came from emerging economies
in Asia, South & Central America, and the Middle East, offsetting declines in Europe and North America.
Source : BPSR
Top Global Oil Exporters…
Region Crude Exports(mt)
Middle East 879.4
Former Soviet Union 319.3
West Africa 224.1
S. & Cent. America 139.0
Canada 111.7
North Africa 72.3
Mexico 67.5
East & Southern Africa 16.6
Australasia 14.2
Europe 12.9
OPEC remains Dominant Player

Source : PIRA
Major Oil Trade Movement…(Middle East,
Europe and US)

Source : BPSR
Choke points

Evolution of Crude oil prices since 1861
1973 o
Price S il
hock

Source: BP
Introduction – Setting the context 1
Functioning of Derivative Markets 3
4 Risk Management

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International petroleum markets
Contracts
Type of Players Term Major Players
Hedgers Spot National Oil Comp.
Speculators Fixed/Floating (NOCs)
Arbitrageurs Cartels (OPEC)
Multinationals
Traders
Pricing Agencies Oil

Platt's Pricing
Argus Benchmarks
(WTI, Brent, Dubai/Oman Avg.,
Tapis)
Premiums or discounts for –
quality variation
regional supply/demand variations….
Value Chain
Upstream
Market Type
Refiners
Physical
Downstream
Derivatives
Shippers
- OTC
- Commodity Exchanges
(NYMEX/IPE/NCDEX…)
• Physical Market
Market Type
Physical oil is sold and bought and the actual seller and actual buyer meet and enter
into a contract to deliver and accept the cargo at a price.
In economic sense, price is what a buyer pays for the utility of the goods that he buys.
In that sense, the price of Crude Oil is the market price in the physical market.
Prices of Crude are generally quoted ‘free on board’ (FOB) at their loading port.
• Paper market
Derivative market which is a logical extension of Physical market.
Derivatives are instruments such as futures, swaps, Options which derive their value
from an underlying commodity.
Delivery can be enforced ( but usually not)

Factors influencing Crude Oil Prices..
• Quality of the Crude Oil
• Demand Supply Fundamentals
• OPEC Policies
• Geopolitical Reasons
• Inventory; Reserves
• Weather
• Currency movement
• Other Markets
Conflicting market forces can induce extreme

market volatility
Quality of Crude …
The API density or viscosity
And why are these

characteristics so
important?
Sulphur content
-- Less than 0.5%  Sweet

– More than 0.5%  Sour
Of course, the price of crude depends on these factors. The lighter the crude and sweeter it is
the higher is the price

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Evaluation of Crude Oil…
Arab Heavy Bonny Light
API 27.8 35.1

Density 0.88 0.8495
Sulphur wt% 2.78 0.15
Visc @ 100F 18.5 5.21
Which Crude is worth More ??
……..

Kingpin Dollar
Currency Movement ..
US Dollar is the currency of choice in global crude oil trade
Oil producing countries receive their oil revenues in US dollar
Consumers use local currencies to buy petroleum products
Dollar depreciation reduces activities in upstream due to

increased cost, higher inflation, lower PP, lower ROI
Depreciation in USD increases the demand for gasoline as US

citizens spend their vacations driving
……..

Inventory…..
• Inventories are needed to match supply & demand
for economic optimization and uncertainty over
 Absolute price levels and the magnitude of the
price changes (volatility) depends on how far apart
demand moves away from supply
 Changes in inventory levels can be used to reduce
the difference between supply and demand, thus
and limit the magnitude or price change
……..

Trading Characteristics of Oil
• Transportation
– Ships or pipelines
– Sizes involved in crude and product transportation
• Processing
– Different types of crude and their relative values
– Refinery configuration
• Storage
– Specialised storage tank at every point in supply chain

Global Crude Benchmarks
WTI and
brent
Brent
Zone
Dubai/Oman
Tapis/Minas
Zone

Benchmark crude oils

Market Terms
Long (Buy):
…….
• If the market goes up, money is made
If the market goes down, money is lost
Short (Sell):
• If the market goes up, money is lost
If the market goes down, money is made

Energy Trading
• Why ……
• How
• What ……
• When
• Where
• Who

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Why We Trade ?
Why Trade
Supply Balancing Hedging Speculation

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What instruments are traded?
Instruments
Physical Derivatives
OTC Exchange
Spot Forwad
Options
Forward Swaps Options Future
……

Who trades
Market Players
Producers Consumers Speculators Market Maker
Crude Oil Producers - Oil Refiners - Day Traders -Energy Companies

Refiners ( Product) - Power Station ( gas) - Position Traders -Utility Companies
Gas Producers - Airlines - Arbitrageurs
Power Station -Trading Companies
-Arbitrageurs
24 Nov 2008 Overview of energy trading

Risk Management
3
4 Functioning of Derivative Markets

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There is More Risk than may appear at first Glance …

What is Risk?
Risk –the uncertainty associated with the possibility of a loss
Financial Markets
Potential for loss arising from unfavorable movements in interest rates, exchange
rates or commodity prices.
Financial Risk
Possibility of incurring a loss, or unfavorable outcome, arising from the future

movement of financial market variables (market risk), performance by
counterparties (credit risk), ability to fund operations or trade in financial markets
(liquidity risk), and/or operational failure (operational risk).
If a loss has already taken place or is certain – it is no longer a risk

Any oil company is exposed to a wide variety of risks. Listed below are key risks that oil
companies are typically exposed to
Market Credit Operational

 Commodity (e.g. crude  Counterparty defaults  Governance & controls
and product) prices  Technology
Components
 Shipping rates  People

 Exchange rates  Geographical
 Regulatory
 High crude prices  Third party suppliers do  System failures

 Refining margins not fulfill their obligations
 Mispriced contracts
squeezed - product  Counterparties go
 Rogue trading
Examples
prices did not move bankrupt

with crude price  Customers do not pay
 Vessel charter rates
may increase

Risk in the Energy World…
Crude Oil->
Producer Refiner
Products : Naphtha, Gas oil, Gasoline, Jet Fuel, Fuel

Participants Oil Price Risks
Oil producers Low crude oil price risk
Petroleum refiners and marketing High crude oil price;
companies
Low product price and
Thin margin
Large consumers High price
Consumer Large distribution companies
(Natural gas)
Unstable prices
Airlines and Shippers High fuel price
Risk Management 3
4 Functioning of Derivative Markets

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Derivatives
• A financial instrument whose value is dependent upon or

derived from one or more basic variables. The derivative itself
is merely a contract between two or more parties.
• Value is determined by fluctuations in the underlying asset.
• Often the variables underlying derivatives are the prices of
traded assets.
• Are simply methods to manage ( hedge) risk.
• Futures, forwards, swaps, options
Derivative – Key Characteristics
• Finite time horizon (i.e. fixed expiry date)
• Requires at least two counterparties
• Represent a zero-sum game between the counterparties.

That is, a gain to one side is a loss to the other side.
• The Payoff is based on the value of the underlying.

OTC Contract
• An over-the-counter contract is a bilateral contract in which
two parties agree on how a particular trade or agreement
is to be settled in the future.
• It is usually from an investment bank to its clients
directly.
• Forwards and swaps are prime examples of such contracts.
It is mostly done via the computer or the telephone.
• For derivatives, these agreements are usually governed by
an International Swaps and Derivatives Association
agreement.
Forward Contracts
Forward contract is a non-standardized contract between two
parties to buy or sell an asset at a specified future time at a
price agreed upon today.
•Non-Standardized- It is custom made as per parties involved.

•Specified Future time- Any time in future when the delivery is to
be made.
•Price Agreed upon Today- Price is mutually decided at the time
of entering into the contract.
•Generally done in OTC market
How Forwards works..
Forward Contract
31/01/13
A agree to Buy 1000 bbl of Crude @ $120/bbl from B on 31st March ,13
Cash Settlement (31/03/13)

Physical Settlement (31/03/13) OR
Suppose Crude Price as on 31/03/13 is
$110/barrel(Loss to buyer)
$120K
$10000
1000 bbl oil
$10000
Suppose Crude Price as on 31/03/13 is

$130/barrel(profit to buyer)
Example(Normal forward contract)
• BP enters into a one month contract with its

customer to sell 1mmbtu of natural gas @
$5/mmbtu, to be delivered on 12th
August,2013.
• If price in exchange is $7/mmbtu on.
• Then there will be a loss of $2/mmbtu to BP
Example(Hedging)
• BP now enters into a one month futures
contract with CME to buy 1mmbtu of natural
gas @ $5/mmbtu,to be delivered on 12th
August,2013.
• If price in exchange is $7/mmbtu on .
• Then there will be a profit of $2/mmbtu to
BP
• Net effect=0
Futures
What is Futures Market?
A location where trading (buy-sell) in commodities is conducted in
accordance with specific rules, procedures, and guarantees.
Futures (Contd.)
FUTURES CONTRACTS
A contractual agreement to buy /sell a particular commodity or
financial instrument at a predetermined price in the future.
•Detail the quality and quantity of the underlying asset.

•Standardized to facilitate trading on a futures exchange.
•Some futures contracts may call for physical delivery of the asset, while
others are settled in cash.
•No counter party Risk.
•CME,ICE,MCX,NCDEX
Forwards vs Futures
Forwards Futures
Available to limited market Liquid market –wider market
participants participation
Lengthy and time consuming Standardized contracts
negotiations
Contract binding on both Positions can be squared off
parties
Counter party credit risk Counter party risk assumed by
exchange
Contd..
Forwards Futures
Bilateral trades & negotiated Transparent price discovery
pricing mechanism
Inadequate dispute settlement Well defined dispute settlement
mechanism mechanism
Difficulty in reporting and The exchange is the central
regulating various trades reporting and regulating entity
Options
• Options are traded both on exchanges and in the over-the-counter
market.
• Two basic types of options.
 A call option gives the holder the right to buy the underlying asset by a
certain date for a certain price.
 A put option gives the holder the right to sell the underlying asset by a
certain date for a certain price.
• The price in the contract is known as the exercise price or strike price.
• The date in the contract is known as the expiration date or maturity.
• American options can be exercised at any time up to the expiration
date.
• European options can be exercised only on the expiration date.
Example
• Mr A buys a European call option with a strike price of
$5/mmbtu to purchase 1mmbtu of Natural gas, the
expiration date of the option is in one month, the
premium price is $1/mmbtu.
• If price in exchange is $8/mmbtu on the expiration
date.
• Mr A will have an option whether to execute the
contract.
• If he executes the contract there will be a profit of
$2/mmbtu.($8-$5-$1)
• If he doesn’t loss of $1(premium).
Example
• Mr A bought an European put option with a strike price
of $5/mmbtu to sell 1mmbtu of Natural gas, the
expiration date of the option is in one month, the
premium price is $1/mmbtu.
• If price in exchange is $8/mmbtu on the expiration date.
• Mr A will have an option whether to execute the
contract.
• If he executes the contract there will be a loss of $2($8-
$5-$1).
• In case he doesn’t execute the contract there will be loss
of $1.
Options – Basic Terminology
• Call Option The right to buy a specified amount of commodity
at a specified rate
• Put Option The right to sell .......
• Premium The price of the option
• Strike Price The rate at which the right can be exercised
• Expiry Date The date on which the right can be exercised
• Option holder Buys the option, has rights, has a long option position
• Option writer (seller) – Sells the option, has obligations, has a short option position
Mechanics of options
Call Option
-- Buyer
Has the right to buy a futures contract at a predetermined price on or before a defined
date. Expectation: Rising prices
-- Seller
Grants right to buyer, so has obligation to sell futures at predetermined price at buyer's
discretion. Expectation: Neutral or falling prices
Put Option
-- Buyer
Has right to sell futures contract at a predetermined price on or before a defined date.
Expectation: Falling prices
-- Seller
Grants right to buyer, so has obligation to buy futures at a predetermined price at buyer's
discretion. Expectation: Neutral or rising prices
Swaps
• “ Swap converts an unknown future price into current fixed price”
• A swap is a purely financial transaction designed to transfer price risk between the swap purchaser and
the swap provider.
• Plain vanilla OTC agreement
• Fixed for floating exchange of risk
• Purely a financial transaction – no delivery
• Settlement:
– If floating price lower than fixed (swap) price – swap provider pays swap buyer
– If floating price is higher than fixed (swap) price – buyer pays seller/provider.
Example – four month fix for Brent crude oil at $25.00 bbl:
Jan Feb March April
• Floating price ($/bbl) 24.50 24.75 25.40 26.80
• Quantity (bbls) 10,000 10,000 10,000 10,000
• Actual cost $ 245,000 247,500 254,000 268,000
• Swap seller pays 0 0 4,000 18,000
• Swap buyer pays (5,000) (2,500) 0 0
• Final cost to buyer 250,000 250,000 250,000 2,50,000
• Cost to buyer $/bbl 25.00 25.00 25.00 25.00
Types of Traders
• Hedgers-reduce their risk by taking an opposite
position in the market to what they are trying to
hedge.
• Speculators- make bets or guesses on where they
believe the market is headed.
• Arbitrageurs- Attempts to profit from price inefficiencies
in the market by making simultaneous trades that offset
each other and capturing risk-free profits.
Example (Arbitrageurs)
• Price in CME is $100/barrel.
• Price in MCX is $101/barrel.
• Cost of transportation from US to India is
$.5/barrel
• In this case a traders will take long position in
US market and short position in Indian Market
thereby making a profit of $.5/barrel.
THANK YOU

11/28/2020 Overview of Oil Trading

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Overview of Oil Trading

 Fundamentals of Physical Trading

 Functioning of Energy Derivatives

11/28/2020 Overview of Oil trading

Functioning of Derivative Markets 3

Overview of Oil trading

Overview of Oil trading

• 1859 – Colonel Drake Strikes oil near Titusville, Pennsylvania

11/28/2020 Overview of Oil trading

What do we get from oil?

11/28/2020 Overview of Oil trading

The life of proven oil reserves is estimated to be 41 years

11/28/2020 Overview of Oil trading

Overview of Oil trading

11/28/2020 Overview of Oil trading

OPEC remains Dominant Player

11/28/2020 Overview of Oil trading

11/28/2020 Overview of Oil trading

11/28/2020 Overview of Oil trading

2 Fundamentals of physical Trading

Functioning of Derivative Markets 3

Overview of Oil trading

Pricing Agencies Oil

Delivery can be enforced ( but usually not)

11/28/2020 Overview of Oil trading

Conflicting market forces can induce extreme

The API density or viscosity

And why are these

-- Less than 0.5%  Sweet

Overview of Oil trading

API 27.8 35.1

Which Crude is worth More ??

11/28/2020 Overview of Oil trading

US Dollar is the currency of choice in global crude oil trade

Oil producing countries receive their oil revenues in US dollar

Consumers use local currencies to buy petroleum products

Dollar depreciation reduces activities in upstream due to

Depreciation in USD increases the demand for gasoline as US

11/28/2020 Overview of Oil trading

11/28/2020 Overview of Oil trading

11/28/2020 Overview of Oil trading

11/28/2020 Overview of Oil trading

11/28/2020 Overview of Oil trading

11/28/2020 Overview of Oil trading

Overview of Oil trading

Supply Balancing Hedging Speculation

Overview of Oil trading

Forward Swaps Options Future

11/28/2020 Overview of Oil trading

Producers Consumers Speculators Market Maker

Crude Oil Producers - Oil Refiners - Day Traders -Energy Companies

24 Nov 2008 Overview of energy trading

2 Fundamentals of physical Trading

Overview of Oil trading

11/28/2020 Overview of Oil trading

Risk –the uncertainty associated with the possibility of a loss

Possibility of incurring a loss, or unfavorable outcome, arising from the future

If a loss has already taken place or is certain – it is no longer a risk

11/28/2020 Overview of Oil trading

Market Credit Operational

 Shipping rates  People

 High crude prices  Third party suppliers do  System failures

prices did not move bankrupt