Oil down almost $5 bbl in just 2 weeks and currently trading below the post OPEC/NOPEC deal. Options volatility moved higher on the price pullback. While producer (commercial) hedging has not been intense, especially as could be expected out of the US, there is now confirmation that Mexico’s PEMEX hedged a sizable clip.
Current market conditions are unattractive for producer structures due to the (1) delta impact with lower prices, (2) relatively high volatility and (3) reduced relative gain from hedging via put spreads.
Price Action: Prompt Brent crude oil is trading ~$52 bbl, level below the post-OPEC/NOPEC deal trading range of ~$55 bbl. Prices are down almost $5 bbl in 9 sessions. The recent selling comes despite strong tailwind for “risk assets” post French 1st round result with higher equities and US yields and lower USD (usually supportive for oil).
The next important support level is at $51.34 bbl (200 day-moving-average) for Brent and $49.93 bbl in WTI – SEE CHART 1 –
A close below these levels will attract CTA/momentum funds selling with a clear aim for prices to retest the $50/bbl “line in the sand”. Note, this level is now a strong support: The failed break and close below $50 bbl in Brent on 22nd Mar, triggered the rise to $56.65 recent high on 12th Apr).
Monitoring Rbob for an early directional signal for oil proved reliable, Rbob must now hold its 100 DMA at 160.17 cts/gal (trading right above as we write). Note the crossover of the 10 day-moving-average (DMA) below the 100 DMA is a short-term sell trigger for trend following funds.
Hedging Flow & Positioning: CTA/trend following fund flows currently are having the most impact on oil prices as producers are not hedging and chasing the market at lower levels. Increased long positions in passive portfolio allocations (i.e. ETF/Index) are highly unlikely given the current prompt contango combined with no new “headlines”.
Oil price is right now sitting on short gamma and short vol positions from US producer hedges that were only placed a few months ago with WTI Bal17 swap trading $50.10 bbl and Cal18 $50.80 bbl. Positioning right on the $50 bbl level, exacerbates short-term volatility as market makers trade the futures to keep their books risk neutral (and by doing so create selling on lower prices and buying on higher prices).
The hedging news (out of Bloomberg) of note is of course that PEMEX hedged ~100 mil bbls via buying a May17-Dec17 $42/$37 Maya put spread. Our understanding is that the Ministry’s annual hedge program is not executed, at least not in volume, (usually Dec-Nov and executed around May-Jul). This hedging clip may explain in part the lower prices we are seeing combined with relatively high options volatility – See chart 2 – and much reduced put premium versus equivalents calls (i.e. lower put skew)

Chart 1 – Brent Price – Daily Since Jan | Source: Bloomberg & CTC

Chart 2 – Brent Price, Implied volatility & Put Skew – Daily 6 mth | Source: Bloomberg & CTC
Fundamentals: Current lower prices are a function of the continued “disconnect” between the shift in crude demand on the back of OPEC cuts. The market is tight for medium/heavy grades and (still) not for light sweet grades. There are numerous reports out there quantifying and commenting on the recent Atlantic basin tanker weakness out of Asia.
A combination of Chinese “teapot” refineries on hold for new quota government allocations, a demand shift to large state-owned companies and the unwinding of 50+ mil bbls of “unreported stocks” (i.e. not reported in energy agencies’ balances and typically the first to be offloaded when market tightens, and implies a time lag between market in deficit vs stock draws showing in data). These factors are happening during peak refining turnaround (estimated at 7 mil bpd in March and April).
Still, the real “negative” market headline still comes on back of continued poor US data: last week (1) large gasoline builds (draws were expected / 3.4 mil bbls diff) and (2) relentless rise in US production (IEA: 9.252 mil bpd / reflected in higher rig counts weeks after week).
The picture remains mixed, however, the DOE showed a 3.6 mil bbls draw in crude and has helped stabilize prices. Near term concern remain with the conversion of a crude oil overhang to refined products, as refinery utilizations increase post maintenance season, a key concern.
It is therefore probable in our view, that weekly US data ahead disappoint versus the expected draws, and as a result provide a potential attractive buying opportunity.
On OPEC, the market still awaits a final decision on deal cuts, and details before the official 25th May meeting. It is evident to us that there is a clear pattern of deal supportive headlines when oil prices trades at the lower end of the range. When oil trades above $55 bbl price (Brent), a more general and less committed language emerges. This leads us to the conclusion that the willingness for deal extension and degree of cuts is market price dependent.
If Brent takes out the $50 bbl lows, we are trading with a high degree of probability that strong, detailed headlines will come to save the day for bulls.
For producers looking to hedge, the optimal time is not now and it would be advisable to hold off.
A full structure (i.e. not to “leg” into it) level to target would be for a move higher in Cal18 to place a premium 3-way hedge such as 40/55/65 in Brent and 40/53/60 in WTI.
The Dec17 straddle is pricing Brent at $62.25 – $43.75 and WTI at $60 – $41.40. The median analyst forecast has 4Q Brent at $53.45 bbl and WTI at $51 bbl.
Contact the desk for further hedging services.

Chart 3 – Producer Hedging Activity Versus Calendar Strip Prices | Source: SDR, MS Commodities
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