Trading Crude Oil & Energy Futures
Energy Futures are Volatile Markets for both Hedgers and Traders
Jan 12, 2009
Historically, the energy markets were an institutional marketplace for hedge accounts on both sides of the market. Upstream oil operators such as exploration and production companies could hedge crude oil prices, downstream operations like refiners and marketers could peg their prices and consumers could depend on a certain price for their use. Enter new market participants such as fund managers and hedge funds, it is a very different market.
Who Trades What?
Besides futures contracts, there are over-the-counter "energy derivatives." While most industrial users of hedge strategies use these OTC derivatives and investment and commercial banks put them together, sooner or later the risk ends up on the exchange floors. Although use varies depending on location, roughly 40% of commercial interests hedge their exposure on a global basis.
Commercial interests that use energy derivatives to hedge exposure are slightly more prevalent in Europe than in North America. These exposures can be crude oil, refined products, natural gas and electricity. The percentage of companies that use hedge strategies can vary widely depending on whether the company is a producer or a consumer of energy and if the market is clearly rising or falling.
As evidenced by the dramatic rise and subsequent fall of crude oil prices, commercial interests are increasingly moving the hedge function from the corporate purchasing department to the treasury depart, often to a dedicated risk management professional operation.
The Evolution of the Energy Market
Needless to say, certain types of companies are major consumers of energy, such as airlines, trucking and rail firms, utilities and so forth. Producers of energy also share the same exposure but on the other side of the equation.
Not unlike vultures, hedge funds and other asset managers can smell an opportunity when price volatility enters the equation and those that are not hedged are at the mercy of the market. Fund managers and hedge funds have in fact entered this market and do significantly add to the volatility; be it rising or falling markets. That doesn’t make it wrong; it just means that’s the way it is.
There has been such a demand by the public to get involved, that commercial and investment banks are originating structured products. Buyers have been not only retail customers but pension funds, hedge funds and other asset managers. Reasons for this upsurge in popularity range from diversification to alpha addition.
Leverage
Very much like other futures contracts, the leverage in energy futures is substantial and is clearly a global market. You would be well advised to study the contract values and performance bonds (margin) before you get involved.
Remember, in any futures market, one can lose more money than they invest. Needless to say, this market calls for a high level of expertise and a pragmatic view of the world and other market participants.
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