Our Brent-linked hedging survey of over 30 upstream players* points to a steady increase in hedging volume. We advise our clients to scale-in hedges progressively given significant tailwinds driving the Brent market.
It is not that the physical picture has dramatically changed, but rather the “mini” North Sea oil glut is improving (tightening Brent spreads). An increasingly bullish view from research analysts provides further reinforcement.
Paper flows are supportive with consumers pushing backend prices higher and hedge funds, underperforming YTD, positioning for higher prices and creating upside pressure.
Brent producers are in an opportune period to execute optimal hedge structures as consumer hedging flows offset their selling.
*For detailed analysis on CTC’s Brent-linked hedging portfolio survey, please contact us.
NORTH SEA “MINI” GLUT
The specialised research side was caught off guard by the relatively weak N. Sea basin situation over the summer. Chinese destocking and cargo liftings from Chinese Teapot refineries, nowhere near expectations, were the key drivers of the deterioration in the physical market.
Indeed, by several metrics, the physical market was signalling that light sweet barrels were available and that refiners had an increasing choice to pick and choose the most economical grades.
Chiefly, the very front of the curve was in contango all the way to Dec18/Jan19. Other signals included a weak N. Sea DFL spread (physical versus paper), widening West African differentials versus Brent and a narrow Brent/Dubai spread, all of which painted a picture of oversupply – predominantly in light sweet barrels. The disconnect between the physical/paper markets peaked in mid-August and led to the “mini” correction that saw Brent trade down to $70/bbl.
SITUATION IMPROVING
The situation in the N. Sea has now improved. Brent timespreads have strengthened and there are signs that Chinese destocking has now finished. The key factor has been a significant draw in Chinese commercial crude stocks, which fell by 30mbbls over the Jun-Aug timeframe.
As a result, Chinese crude oil imports rebounded in August and grew by 240kb/d MoM and 830kb/d YoY. Strengthening West Africa crude differentials also suggests that Chinese demand is finally returning.

BRENT TIMESPREADS & PHYSICAL SIGNALS IMPROVING
Not only Chinese demand, but Asian and EU refinery margins are impressively strong.
Importantly, this highlights strong refined product end user demand despite headline risks associated with an escalation in trade wars between the US and China. Unplanned EU refinery outages over the summer (hot temperatures, low water level in the Rhine River)
also contributed to lower refining utilizations (less crude oil demand and higher refining margins) during the summer heat wave.
With these problems now resolved, EU refiners are increasing refining utilizations, a key contributing factor towards rebalancing the Brent market. Finally, crude oil floating storage shows impressive draws of 30-40mbbls over the summer period (ClipperData).

Brent price with historical forward curve points to a repricing of long-term Brent price
IRANIAN EXPORTS
The implementation of US sanctions on Iran is still more than 2-months away, however the impact is already being felt as Iran oil exports are rolling over… hard. Vessel tracking data from Reuters and ClipperData show Iran exports below 2mb/d in August. The fall is dramatic, from a peak of 2.7mb/d in April 2018.
The market expects a further fall as the November deadline approaches. The September loading program has been reportedly set at 1.5mb/d with a growing list of Europe and Asia buyers switching to alternative sources such as Urals and Basrah Light.
“The street” now factors in a 1.0-1.2mb/d decline in Iranian oil exports as a result of US sanctions.
While these forecasts suggest that oil prices fully reflect the impact of lost Iranian barrels, the quick recovery in oil prices highlights that a reduction in Iranian exports of this magnitude, in conjunction with oil supply uncertainty in areas such as Libya, Venezuela, Angola and Nigeria, are an explosive cocktail of events into year-end.
Still, we are monitoring as market expectations could be dented as trade wars and geopolitics may change the situation on the ground (or change the market’s perception of the situation).
Already Iraqi exports are increasing notably (a picture similar to 2012 Iranian sanctions). Turkey, now that it finds itself “cornered” financially, could prove to be a facilitator for at least some of these sanctioned barrels.
CHINA’S “OPTIONALITY”
China is probably the most important variable here as it finds itself a sort of de facto “swing buyer” for Iranian barrels. It has a capacity to play a pivotal role by continuing to import ~300kb/d of US crude or by pressing “where it hurts” (switching US for Iranian imports).
To some extent, the “swap” optionality China has on part of Iranian barrels gives it leverage with regards to ongoing US negotiations.

5-YEAR DEFERRED DATED BRENT SWAP HIGHER
HEDGING PAPER FLOWS
The investor community has reduced long exposure by over $25 bil in the very front of Brent alone since its peak YTD. This is huge by any standard.
Who has taken the other side of this selling? Clearly consumers, and particularly airlines, in what seems to us to be a sudden and bizarre IMO 2020 wakeup call. This is significant. Consumer buying was concentrated in 2H 2019 and extends now well into 2021.
In fact, the 5-year deferred dated Brent swap above $69/bbl is at a 3-year high. On the other hand, front month Brent is still $3/bbl below the recent May-18 highs. Clearly, the market is stating its longer-term concerns of dwindling OPEC spare capacity and under investment.
The result is that the backend of the curve has moved significantly higher as airlines push prices (and pushing it higher on themselves in our view). It also means that there are optimal moments for Brent-linked producers to hedge – CONTACT US FOR MORE ON THIS.
Producer hedging was negligible over the summer and has picked up in past trading sessions: A large producer hedge has been going through the Brent market, with timing and duration mirroring the sovereign Mexico hedge. However, the structure of the deal (narrow put spreads) points to another active producer. This is in-line with our analysis, CTC expects to see an acceleration in producer hedging activity.
The recovery in oil prices in the past 10 days though has been front end led (i.e. time spreads stronger) with growing interest in upside calls as hedge funds position for a “supply crunch” narrative with the loss of Iranian barrels into year end.
Our analysis of investor flows points to a return of passive index money to the oil market sector, which will surge if backwardation returns to the very front end timespreads.
Simply, investor positioning has cleaned up significantly over the summer and there are large investor flows on the sideline, ready to enter as the narrative into year-end intensifies with a focus on lost Iranian barrels and falling OPEC spare capacity.

CTC BRENT-LINKED PROPRIETARY HEDGING SURVEY
PRODUCER HEDGING SURVEY
We recently completed our producer hedging survey, which analyses the Brent hedging programs of over 30 international E&P companies. The survey reviews differentiated hedging strategies broken down by producing region and company size.
It provides insightful data where companies can benchmark hedging books relative to peers and industry averages. For more details on CTC’s Brent-linked hedging portfolio survey, please contact us.
CTC TRADING VIEW
The market is skewed, from a risk/reward perspective, to the upside.
Our analysis points to passive index money returning quickly as front month spreads are setup to flip into backwardation. The paper market sentiment is buoyed by a supply crunch narrative that is intensifying. Hedge funds are driving this narrative as earlier concerns on emerging market demand have been brushed aside (at least for now).
With potential for price explosivity into the rollback of US sanctions on Iran, we recommend that producers scale in progressively, adding to positions more aggressively as the supply narrative hits a crescendo. We believe that for Brent producers right now, the most important variable to monitor is consumer hedging flows pushing the backend of the curve significantly higher.
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Commodities Trading Corporation is a London-based private advisory company specialized in commodity risk-management, hedging & trading. We service a growing need in the natural resources sector for unbiased and strong expertise and provide our services to an array of corporate clients and financial institutions. We are experts in derivatives and monetizing volatility and develop corporate strategies for hedging energy portfolios, using bespoke derivatives solutions for price risk mitigation.
For more information on CTC, insights on risk-management strategies & trading views, contact us at contact@comtradingcorp.com.
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