Low Brent creates window of opportunity for hedgers, say analysts

Swooning prices for Brent crude oil have created a window of opportunity for firms to lock in their fuel costs via forwards and options, before prices pick up again towards the end of the year, say analysts.

North Sea Brent crude oil futures have seen a sharp drop in prices over the past few months. From a peak of around $119 per barrel (/bbl) in mid-February, the contracts dipped to under $100/bbl during April. Having briefly rebounded in May, the front-month futures contract closed at $100.39/bbl on May 31, before rising to $102.06 on June 3, according to Ice Futures Europe. The forward curve has remained relatively flat and in backwardation – meaning that longer-dated futures trade at a premium to shorter-dated contracts.

These low prices aren’t expected to last forever – and as a result, analysts expect an upsurge in hedging activity from corporates. “There is definitely expected to be more demand from the refining side and definitely these levels are there for the hedgers to come into the market and start buying,” says one senior analyst at a major European oil producer and trader. “There is room to come in and take positions.”

Harry Tchilinguirian, London-based head of commodity strategy at BNP Paribas, agrees. “The fact we have come down on Brent to around $100/bbl and with a backwardation in the curve [means] it’s certainly very attractive right now to be buying Brent calls and selling the puts,” he says.

The sale of put options on Brent would reap a premium for corporates, while buying call options would enable firms to gain exposure to potential price increases that might follow the recent lull.

Some of the biggest hedgers in crude oil are airlines, which often use it as a proxy for their jet fuel costs. Amrita Sen, London-based oil market analyst at consultancy firm Energy Aspects, says many airlines have already hedged most of their fuel costs over the coming years. However, she believes the current slide in prices might cause some to re-enter the market opportunistically. “In 2013 and 2014, a lot of the airlines are fairly well-hedged, but they can still put on some more hedges. They used to hedge out four to five years and now they’re doing a few quarters out – and 15 months out maximum,” she says. “They would be looking at the balance of 2014, and very few would do 2015 at this stage, but there could be some opportunistic buying.”

Amid Western sanctions on Iran and a 30 million barrel per day production ceiling set by the Organization of the Petroleum Exporting Countries (Opec), Brent prices are unlikely to get much lower, warn analysts. But at the same time, it is thought that a weak economic picture will prevent any unexpected spikes.

Tchilinguirian expects prices to begin trending upwards again in the third quarter. “You can see Opec countries burn a lot more crude oil directly in their utilities to generate electricity,” he says. “You could have very strong swings in demand for countries such as Saudi Arabia, and as a result, spare production capacity will become strained again, which it isn’t currently. So that’s an economic and fundamental catalyst that we could see that will allow prices to move higher.”

Analysts at Goldman Sachs expect front-month prices to see modest rises between now and the beginning of 2014. Prices for front-month Brent should rise to around $103.5/bbl during the third quarter of this year and $105/bbl in the fourth quarter – a level they expect to persist throughout 2014.

Sen at Energy Aspects is more bullish, however, believing that a recovery in the eurozone could push prices even higher. “In the third quarter, you’ll start to see a pick up and that should help prices go up towards $110/bbl,” she predicts.


This article was first published on Risk

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