Thread by @alkd1976

Professional commodity traders rarely ever trade price. The bulk of the volume in commodity trades are in spread trading. Different types of spreads traded
1. Calendar spreads (contango or backwardation)
2. Location basis spreads (wti-brent)
3. Refining spreads ( gas/heat cracks

4. Cross commodity spreads (crude to natty)

Most of these spreads are a function of relative fundamental supply and demand. Will explain each and what the fundamental drivers of each are soon if people are interested

Would you be interested in learning more about commodities? Feel free to retweet. If there is enough interest will think about next steps to reach a wider audience

Crudeoil as a commodity has 4 principal areas of demand.
1. Transportation (gasoline, diesel, jetfuel, residual oil)
2. Weather (propane, diesel)
3. Economic growth. Plastics or petrochemicals (naphtha, ethane, propane)
4. Power (diesel, residual oil)

Crudeoil by itself cant be consumed directly. It has to be refined into the various fractions at refineries. A refinery has various units to refine the different fractions. Some of these are crude distillation unit or cdu, fluidised catalytic converter or fcc, vaccum distillation

Unit or vdu, coker, hydrotreaters, hydrocrackers. Each of these serve a specific function in producing the various different fractions namely gasoline, diesel, jetfuel, naphtha, lpg, residual fuel oil and coke.

The two main consideration in which units are run to maximise yield of each product are economics and crudeoil specifications. There are two broad types of crudes sweet and sour (sweet better than sour because it has less sulphur in it) sulphur bad for refining

And light and heavy. Light crude better than heavy because they have a higher concentration of the valuable fractions namely naphtha, gasoline, jet and diesel. Heavy crudes are loaded at the bottom of the barrel namely residual fuel oil which need more processing to produce the

Good stuff. There are 3 main marker crudes in the world that trade on the global exchanges. Wti or west texas intermediate, brent, and dubai. Wti and brent are both light sweet crude while dubai is a medium sour crude. The quality of crude is defined by a metric called API

Higher the API the better the crude. Wti has an api of 38 and so does brent. Dubai is about 30 and some of the heavier crudes like saudi heavy or mexican maya have an api of sub 20

Among the refined products gasoline and heating oil or diesel are traded on the nymex and are super liquid. So two liquid spreads traded on nymex are the gas crack and heat crack which is the price difference between crude and gasoline or crude and heating oil quoted in $/bbl

The remaining products trade in the otc market. There are brokers who will make a market for residual fuel oil, propane, naphtha, jetfuel and u can create a synthetic spread by say selling fuel oil and buying crudeoil or buying propane and selling crude oil depending on your view

The main fundamental driver of the refining spread is the relative fundamentals of crude and refined products. Refinery is a big piece of that. Suppose a big refinery has a problem and stops running crude (haapens all the time)
Now crude demand is gone since refinery stops

Consuming crude and products are in shortage. Gas cracks and heat cracks both will rally hard. Gasoline prices rally and crude prices fall

Calendar spreads are fundamentally driven by storage economics. Crude is produced around the world and transported on oil tankers and pipelines to the refineries. Crude trades on a forward basis since there is a transportation lag between ordering and delivering

Lets assume that the world produces 90m bbls a day and in a perfect world we consume all of it as all refineries are operating. The world supply demand is in balance. Suppose now that a 1m bbl/day refinery has a fire and is shut down.

Crude is still produced at 90m bbls but my demand now is 89m bbls. The excess 1m bbls has to be dumped into storage. If storage is available the producer pays the cost of storing of about 30 cents a month and we are again balanced. But this forces the natural shape of crude curve

Into contango where the next month delivery trades at a 30 cent premium to the first month to account for the storage cost. As storage fills up and suppose u reach a state where the world storage tanks are completely choke bloke full with crude. In that case u go

Into super contango where the first month crude disconnects from the rest of the curve and falls in price to find the marginal buyer. On the reverse side say we r balanced at 90 m bbls and say all refineries running full steam but saudi has some problem and shuts down 1m bbl/ day

Production. Now we are short crude and if there is sufficient crude in storage tanks we can draw on it. If the storage tanks are empty we go into hyper backwardation where the front month crude will spike and disconnect from the rest of the curve to kill off demand

This is where the bulk of calendar spread trading happens. And why the wed weekly eia inventory numbers are such a price mover.

Forecasting weekly inventory on crude is an extremely difficult job and at best even the experts will be guestimating. These numbers historical and fresh wed changes can be found here

eia.gov/petroleum/supp…

Among the different energy commodities the heirarchy of ease of analysis is as follows
1. Electricity
2. Natgas
3. Crudeoil

Electricity supply demand has to be balanced in realtime since there is no storage for the most part electricity s&d

Easiest to analyse. Power supply stack is one key driver and of course weather forecasts. If its hot airconditioning demand and if its cold then heating demand drives power s&d along with industrial demand

Natural gas for the longest time was landlocked until lng (liquiefied natural gas) started. With lng natural gas fundamental analysis has become almost par with crude though not as difficult because natural gas is natural gas no matter where it comes from but crude has quality

Natural gas has 4 main demand areas
1. Heating demand (weather)
2. Industrial demand (chemicals and fertilizers) as a raw material
3. Transportation through CNG (compressed natural gas)
4. Power stack (as a competing feedstock vs coal diesel residual fuel oil)

Natural gas supply is from underground reservoirs or as a by product of drilling for crude. For the most part this supply is fairly stable all year round while demand has a seasonal profile so in the summer there is excess which goes into storage and in the winter

Demand exceeds supply and we draw naturalgas from storage. Until lng started each landlocked region had the following balance
Supply - demand = change in inventory
Now we have to account for import of lng which is regassified or export of lng which is liquiefied

So the new balance for natgas is
Supply-Demand+ import of lng - export of lng = change in inventory and this is the same balance for crude oil as well only difference is crudeoil needs to be further analysed for where it comes from since each part of the world has different

Type of crude. So we need to understand the supply demand of crude for each region to understand the balances which then affect the change in inventory which affect all the different spreads and ofcourse the entire curve shift as well

There are so many other factors that drive the basic analysis to generate a point of view on whether u are bullish or bearish and then comes the hard part of translating this pov into a trade strategy. There are so many ways to play the same pov through spread trading

So another type of spread that trades is the one between gasoline and diesel. Gasoline demand in the us peaks in july aug as summer driving season ends and winter heating oil demand picks up. Most refineries will turnaround in sep/oct to switch refining config from fcc

Which maximises gasoline production to a hydrocracker which maximises diesel/heat production & these seasonal demand switches are one of the fundamental drivers of the gasoline heat spread. I am generalising here guys but just an example of the kind of things that affect spreads

Refineries go from a scale of simple to complex based on a nelsons rating factor. Higher the nelsons factor the more complex a refinery is which means it has the highest flexibility in terms of which crudes it can process and can switch units to maximise yields of the profitable

Products. In india reliance has the one of the most complex refining assets in the world. Ioc comes next then bpcl then hindpetro which has mostly simple teapot refineries from my understanding.

Some of the most interesting plays in the energy markets happen in aug/sep/oct period. Thats when hurricane season in the us gulf of mexico begins. Living through these is a nightmare so am not a fan of the hurricanes but from the trading perspective they provide some of the

Most facinating fundamental trades. As an example we used to forecast the path a hurricane is going to take and whether its going to hit production/ refining assets on the gulf coast of the us or curve into florida where there are none and some of our biggest trades were getting

This right. Us has a lot of refineries in louisiana and texas on the gulf coast and also a lot of offshore production in the gulf of mexico. So if hurricane was going to hit crude production buy calendar spreads on wti. If refineries were to be hit buy gas cracks and heat cracks

Location Arb on crude is played via the wti-brent spread. Three fundamental factors affect this arb for the most.
1. Quality difference of the crude. Even though both are light sweet each one when refined produces a different blend of products and depending on product price

Differentials there could be a relative value difference between the 2 crudes. Refineries will run complex lps to optimize each crude slate
2. Transportation costs. The cost to bring brent from northsea to the gulf of mexico or the east coast of the us

3. Relative product prices in the east vs west. Brent is the marker crude for all crude east of europe so all west african crude and most asian light sweet crudes trade as a differential to brent. There is an asian light crude called tapis which is often used as marker crude

But mostly its brent. For the different types of crudes and their prices one can look up the platts publications.

So if for eg asia is short light crude they will aggresively pull on brent and west african crudes increasing the value of brent relative to wti.

Posting a few charts on term structures of crudes and crack spreads. Will probably be bouncers for most but ask away and well try to answer to the best of our abilities

The data for these term structures was taken from nymex. Here is the link to the same in case you want to play around with the data

cmegroup.com/market-data/se…

This ends the weekend commodities gyan. Will think about more by next weekend and will update the thread. Till then back to my day job 😂😂

Ok one last one chart and then i am done with commodities till next week. This is weekly crude oil inventories for the past 10 years