Published on April 10, 2008
Slide1: Fuel Oil Price Risk Management … and perspectives from the financial side Hartley Connett Executive Director, Marketing Mitsui & Co. Energy Risk Management (U.S.A.), Inc. 2007 Fuel Oil & Energy Buyers’ Conference October 31, 2007 Slide2: $100 Crude Oil … option players have real money on the table Source: NYMEX, Bloomberg LP Slide3: Fundamental Drivers in 2007 Global Security Risk Iraq and The Middle East Nigeria Turkey and PKK (recent) Global Supply & Demand Balances Economic Expansion in Asia OPEC production Cuts No significant excess capacity outside OPEC In OPEC, only the Saudis Weaker US Dollar US Refining stress Tokyo Electric Power Co. (more recent) Asian fuel oil supply constraints develop later in year (more recent) Lower Russian exports Iran becomes importer Slide4: 12/29/06 Saddam Hussein Execution Large short put position on NYMEX 01/23/07 – Proposal to increase SPR to 1.5 billion bbls. 3/20/07 OPEC keeps level Unchanged 3/22/07 Iran captured 15 British Soldiers 9/01/07 US Inventory shows much larger than expected drawdowns Mid August Hurricane’s do not materialize in US 5/10/07 Disruptions from Nigeria and Start of US Driving Season 10/28/07 Oil follows Equity Market reaction to Subprime Crisis 7/16/07 TEPCO Outage 2007 Timeline: NYMEX Spot WTI 10/15/07 Turkey / PPK Source: NYMEX, Charts provided by Future Source www.futuresource.com Recently, New US Sanctions against Iran Slide5: Consumer Hedging Discussion 3 Simple Themes in a Core Hedging Strategy Theme 1- Historical Price Distribution … Where are current prices versus historical distribution? Theme 2- Forward Curve and Best Value … Where is the best value along the curve? Theme 3- Product relationship to Crude Oil … What are the crackspreads doing? Slide6: Consumer Hedging Theme 1 ... Where are current prices along the historical continuum? Theme 1 Prices in 2008 (and beyond) are at the highest portion of the historical distribution curve Accumulate at the averages, add more aggressively below if opportunity presents. Current prices are far from the ‘best world’ from a Consumer’s standpoint For Consumer Hedging, the recommendation is to use Defensive Strategies Slide7: Hedging Theme 1 – Applicable Strategies Examples of Defensive Strategies … Option products are effective. Caps … ‘price insurance’, plain vanilla, upfront premium in return for upside price protection above a certain price. Weigh Premium Cost versus Opportunity Cost. Collars … plain vanilla, purchased cap financed by sold floor, typically designed to be costless Capped Swap … a vanilla swap with an embedded option, provides enhanced (lower) fixed rate swap in return for a maximum upside payout Capped Collar … enhanced collar (lower floor and/or more valuable initial cap strike) in return for maximum payout above the cap Slide8: Hedging Theme 1 – Simple Cap Strategy Premium Outlay versus Opportunity Costs … below is a simple illustrative example of option premium compared to historical price ranges (using WTI) 2008 Swap +10% Strike Premium 2009 Swap +10% Strike Premium USG 3%($/bbl) 65.85 72.50 2.50 62.75 69.00 3.95 3.5% Rot Barge($/mt) 419 450 18.00 397 440 24.00 Sing 180($/mt) 452 500 15.00 429 475 25.00 (Prices are indicative only as of c.o.b Oct 26, 2007) Source: NYMEX Slide9: Hedging Theme 1 – Other Common Strategies Capped Swap and Capped Collar For 2008 Calendar Period Capped Swap (Platts USG 3%, $/bbl) Compared to the Vanilla Swap, achieves a lower fixed rate in return for maximum upside payout. Vanilla Swap: $65.85 Capped Swap: $63.00 … with $7.00 / bbl maximum upside payout, or ‘capped’ at $70.00 / bbl. Capped Collar (Platts 3.5 % Rot Barges, $/mt) Achieve an enhanced collar in return for a maximum payout above the cap strike (costless examples). Vanilla Swap: $452 Buy Cap Sell Floor Max Payout 2-way: $475 $435 - Capped: $450 $425 $50 … with $50.00/ mt maximum upside payout, or ‘capped’ at $500 / mt 0 In-the-money Out-of-the-money Underlying Price Direction Payout Graph 3-Way Collar vs. 2-Way Collar Fixed price swap 0 In-the-money Out-of-the-money Underlying Price Direction Payout Graph: Capped Swap Fixed price swap Slide10: Consumer Hedging Theme 2 ... Recognize the shape of the forward curve Theme 2 Looking for the ‘best value’ along the curve … Extending tenors in a backwardated market improves average price hedge for the consumer Value for consumers in the lower forward oil curve Lower volatility in forward markets … Currently, all of the major global fuel oil swap indices are in backwardation. For the consumer, a lower forward price = better value Source: Mitsui Internal Database Slide11: Hedging Theme 2 – Applicable Strategies Extending tenors in backwardated fuel oil markets In backwardated markets, consumers should consider extending tenors to achieve a lower average price ... Vanilla Swaps Option products can also be effective … Hedging with Extendible Structures (option embedded products) Extendible Swaps Extendible Capped Swaps Extendible Collars Extendible Structures – general explanation Consumer obtains an enhanced hedge (fixed swap or collar) for an initial period. In return, the consumer grants the counterparty (Mitsui) the right to extend the terms of the initial hedge into a future period (pre-determined at outset). The extendible portion can only be exercised 1-time on a pre-determined date, at the preference of the counterparty. Slide12: 2009 Extendible portion Hedging Theme 2 – Extendible Example Extendible Swap Example Calendar 2008 (into 2009) Sing 180 FO ($/mt) Cal 2008 Swap: $452 Extendible Swap: $430 2008 swap 2008 Extendible swap The option to extend the 2008 swap into the lower 2009 forward price period – and the value inherent – allows the consumer to achieve a lower initial swap rate for 2008 Extendible Swap Terms: Consumer has a fixed rate hedge for all of 2008 Counterparty has the right to extend the 2008 swap terms into the calendar 2009 period. 1- time exercise on extendible portion at the end of the 2008 pricing period. If the Counterparty exercises the extendible portion, the consumer will have a fixed rate swap for the 2009 period. This structure can also be applied to capped swaps and collars Source: Mitsui Internal Database Slide13: Consumer Hedging Theme 3 ... Watch the fuel oil crackspreads Theme 3 … To hedge with Crude or Fuel Oil? In 2007, it made a difference! A stronger crack environment lessens the benefit of WTI hedges A weaker crack environment lessens the benefit of Fuel Oil hedges What to do for 2008 or beyond? If view supports stronger cracks (or if they are historically low), fuel oil will be the best bet Weigh ‘liquidity costs’ of fuel oil versus ‘accounting costs’ of WTI The crack relationship can be dynamically managed Slide14: Take away; The 3 Core Themes Theme 1 - Historical price continuum Use Defensive Strategies at the Highs, use more aggressive strategies at the historical averages or below Options can help! … look at premium in context to historical ranges and volatility … being ‘wrong’ premium can be [much] less expensive in the long-run Theme 2 - Look for best value along the curve In backwardated markets, extend tenors to achieve lower average hedge price … extendible strategies work well … lower volatility in forward periods Theme 3 - Watch the product-to-crude oil relationships Refiners do! … can help achieve more effective hedge results ... also a Defensive Strategy Slide15: The Longer Fundamental Outlook Supportive fundamentals remain in place … adding specific factors to the residual sector Existing fundamental drivers remain in place for the most part Adding … Global Supply & Demand Imbalance Q3 global stock draw Implied Days Supply US Total Petroleum Inventories heading towards lower end of the historical average Adding for residual sector … Projected global fleet size by 2010 (long-term) Longer-term impact of upgrades for refinery coking and hydrocracking units on global RFO supply (long-term) Bottom line … the overall picture remains Bullish. Source: Bloomberg LP, EIA Slide16: The from Contango to Backwardation … supports the theory of a fundamentally tight market Spot NYMEX with 1st Line vs. 12th Line Crude Spread backwardation contango Charts provided by: Future Source – www.futuresource.com FLIP Slide17: Bearish factors? Technical ‘blow-off’ Mild Winter Weather Economic Recession Calming of Tensions in Oil Sensitive Regions OPEC pumps More Oil The ‘Oil Burden’ Uptrend line - support support NYMEX WTI – Daily Spot Continuation Charts provided by: Future Source – www.futuresource.com Slide18: Short-term Observations on Fuel Oil Asia Singapore prices are leading the way at the moment Depleted Russian exports into Singapore Iranian product out of the market Pull of product into the Arab Gulf Europe Poor demand at moment for Utility spec bbls Healthier demand for Bunkers Med Stronger demand for 1% coming from Mediterranean Utilities Buying Med 1% / Selling NWE 1% US Is 1% FO high vs. Natural Gas? A trade we see interest in Source: NYMEX, Bloomberg LP Slide19: The SPR(s) and Crude Oil Prices Not the only factor of course, but a ‘wild card’ going forward Going forward, SPR policy of the US Administration will deserve attention, as will China’s SPR policy Source: Bloomberg LP , NYMEX Slide20: New York Telephone: +1 (212) 878 6750 Asia Telephone: +44 20 7489 6741 London Telephone: +44 20 7489 6741 Sydney Telephone: +61 2 9256 9596 Thank You For Listening LONDON SYDNEY NEW YORK SINGAPORE Mitsui & Co. Energy Risk Management, Ltd. Worldwide Locations TOKYO Hartley Connett Executive Director, Marketing Mitsui & Co. Energy Risk Management (USA), Inc. As agent for Mitsui & Co. Energy Risk Management Ltd. 200 Park Avenue 31st Floor New York, NY 10166 Desk- 212.878.6750 Cell- 914.907.7508 Fax- 212.878.6756 email@example.com
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