This article originally appeared in the end of year issue of Risk Desk.
The biggest story in energy in 2017 is clear: This was the year that the US energy industry truly connected with the rest of the world as a major exporter of crude oil and natural gas. The trickle of exports unleashed by the repeal of US crude oil export restrictions in December 2015 became a major gush during 2017. These exports have helped to reshape the map for physical product flows as well as for energy derivatives.
CME Group’s NYMEX West Texas Intermediate (WTI) light sweet crude oil futures have always been the key price discovery mechanism for the oil markets since its launch in 1988. But back then, no one could have imagined just how global the WTI benchmark could become. The speed with which US oil producers have responded to the repeal of the export ban has caught virtually everyone by surprise.
During some months of 2017, the US shipped more than 1 million barrels per day of crude oil, including a record-breaking 1.73 million barrels per day in October. Derivative markets reflect physical energy flows and so the surge in US exports has given a new impetus to the use of WTI as a risk management tool. More than 1.25 million contracts per day of WTI have traded on average during 2017 to date, an increase of 14 percent year on year.
The connection to a strong physical growth story has enabled WTI to easily surpass its nearest rival, Brent, which is located in the declining North Sea production region. The strong uptake of WTI by the physical oil industry can also be seen through the surge in large position holders and in repeated open interest records. Most recently, WTI futures set an open interest record of nearly 2.7 million contracts on Nov. 10.
These results are extraordinary for a mature contract like WTI, particularly given the relatively low volatility that the oil markets experienced in 2017, at least in comparison with the rollercoaster ride of recent years. The 30-day, at-the-money (ATM) implied volatility in WTI options has averaged around 27 percent in 2017, which is significantly lower than the observed average levels in 2015-16, when ATM volatility averaged 42 percent.
One of the key drivers for this recent growth has been the amazing level of interest in WTI from Asia during 2017. The US has gone from sending virtually no crude oil to Asia in 2015 to shipping 350,000 barrels per day to the region in the first nine months of 2017, the latest period for which official figures are available from the Energy Information Administration (EIA).
Strong Asian demand for US crude oil has led to strong demand for risk management from Asian consumers. Before the lifting of the export ban, activity in Asian hours typically accounted for 2-3 percent of overall WTI futures traded volumes at CME Group. In recent months, Asian time zone activity has soared and now accounts for as much as 18 percent of overall volumes of WTI. This has made WTI the most liquid energy derivative that is traded in Asian hours.
Asian refiners are also increasingly looking at the full range of North American grades. Even more dense and viscous US crude oils such as Mars, which is produced in the Gulf of Mexico, have found favor with Chinese refiners, despite the huge distances involved. CME Group has listed risk management products on many of the various US and Canadian grades, based on price assessments by Argus Media. These grades typically trade as a differential to WTI and interest in these products continues to grow.
Although US crude oil has grabbed most of the headlines, the same trend toward exports has also been replicated by the US natural gas sector, which is poised to become a major global exporter through the medium of liquefied natural gas (LNG).
CME Group’s NYMEX Henry Hub natural gas futures contract has been the world’s most traded natural gas futures contract ever since its launch in 1980. Henry Hub was originally designed to be the benchmark for the US domestic market, but it has since evolved into a broader role as the major global natural gas benchmark. In fact, through the first 11 months of the year, Henry Hub natural gas futures have averaged nearly 425,000 contracts per day, which is increase of 12 percent year on year. Most recently, Henry Hub futures reached a new, single-day trading volume record of 893,256 contracts on Dec. 7, surpassing the previous record of 824,316 contracts on Jan. 23, 2012.
Note the Wall Street Journal story, “Henry Hub Emerges as Global Natural Gas Benchmark,” at http://www.cmegroup.com/education/files/henry-hub-emerges-as-a-global-gas-benchmark.pdf
Cheniere’s Sabine Pass terminal in Cameron Parish in Louisiana started exporting LNG in February 2016. Several other brownfield and greenfield LNG projects are under construction and are expected to come on line in the next few years, mostly in the Gulf of Mexico. According to EIA estimates, these projects are expected to increase export capacity to 9.2 billion cubic feet per day of natural gas by 2021. As US LNG exporters become the swing producers for the world, this will make Henry Hub an even more important price reference in global gas trading.
Price activity has been relatively subdued in the energy sector in 2017, but a return to more typical patterns of volatility the challenge facing can be expected in 2018. Firms that are concerned about potential dramatic energy price movements are increasingly hedging their exposure with CME Group’s suite of options products.
WTI options are the world’s most actively traded crude oil options contract and electronic volumes have increased by 1.7 percent in the first 11 months of the year. Customers are increasingly turning to options to protect themselves from a potential price breakout from what has been a relatively tight trading range in 2017.
Electronic trading also has improved accessibility to energy options dramatically and has attracted new participants. Only around one-fourth of WTI options were traded electronically in 2012, but this share surpassed 80 percent by late 2017.
Looking ahead, the CME Group’s energy business has positioned itself to take advantage of the strong performance of the US energy complex in 2017, which has moved with astounding speed to leverage new export opportunities. US energy exports have become a key factor in the global marketplace and this trend looks set to continue as oil exports continue to ramp up and as new LNG facilities come on line. Our WTI and Henry Hub benchmarks enable both exporters and importers to manage their price risk appropriately and we stand ready to help our customers hedge a potential return to normal volatility levels driven by the tension between increased physical supply and continued strong overseas demand in 2018.
Derek Sammann is CME Group’s global head of commodities & options.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
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