Low volatility is translating into less liquid energy commodity markets

There has been considerable discussion of late about the lack of volatility in some key trading markets, and the impact that is having on trading groups, their profitability, and thus their interest in remaining engaged in certain markets.

The argument has been that low or relatively flat prices have driven some key trading firms — a fair number of which are big banks — from a number of commodity markets, including energy commodities. Some believe the liquidity of some of these markets has taken a hit as counterparties have left, both because of reduced profitability but also as a result of regulatory pressures.

The situation has been building gradually over the past year and a half. Some  point to  Vitol’s 20% decline in 2013 pre-tax profits that the world’s biggest oil trader revealed in May as the prime example of how trading in commodity markets has slowed.

Vitol’s CEO Ian Taylor called 2013 a “very challenging year for many in the physical energy distribution business,” as margins were already being pressured by a relatively stable crude oil market. Vitol handles no less than 5 million barrels of oil and refined products a day.

Yet the slow-down in trading has persisted into 2014, and can be seen most starkly in financial trading. According to a Platts review, “trading volumes in energy futures product s have been caught in a declining trend so far this year as major price fluctuations came to a standstill.”

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Platts collected data from a variety of sources. In its internally distributed April 2014 Market Activity Report, Platts noted that “leading exchanges such as ICE and CME reported plunging energy volumes for the month of April compared to levels reached last year.”

It said that CME reported “a 25% drop in average daily volume in its energy product line compared with April 2013,” while ICE reported “a similar 21% drop in total energy average daily volume for the same time frame.” The report said that both exchanges attributed the “lack of trading interest to low price volatility.”

Platts looked at the price swings, or the standard deviation around an average price, of oil and oil products. A high standard deviation means elevated price volatility, the review noted, while a low deviation demonstrates what the report called “muted price swings.”

Monthly standard deviation crude. Source: Platts Market Activity Report, April 2014

Monthly standard deviation crude. Source: Platts Market Activity Report, April 2014

The report says that, compared to April 2013, NYMEX crude’s standard deviation in April 2014 was down “about 44%,” while ICE Brent, “which has been surprisingly quiet as geopolitical tensions heat up between Ukraine and Russia, saw its standard deviation plunge 54% in April compared to year ago levels.”

The Platts review said that NYMEX heating oil futures saw its standard deviation fall about 49%.

These products have traded in very narrow price bands “without major catalysts to cause a breakthrough in prices.”

As examples, it says, “So far this year, Brent futures have traded in a remarkably narrow $6.14/b trading range,” with the range between the highest price and lowest price of the year “miniscule compared to the $37.97/b spread in 2012 and $21.04/b band in 2013.”

The NYMEX crude trading band of $13.26/b so far this year compares to $31.80/b in 2012, according to the report, and to $23.67/b in 2013.

Heating oil futures have traded in just a 35 cents/gal band so far this year, compared to 77 cents/gal in 2012, and 50 cents/gal in 2013.

The narrow trading ranges and relatively low standard deviations “make it less favorable for market participants to actively trade oil and product futures,” the Platts review says.

As a result, the review says, “volumes have fallen precipitously for the most active oil futures contracts throughout 2014 and are down considerably from year ago levels.”

Platts says the data shows that NYMEX crude has experienced a 13% drop in the average daily volume from January, and about a 26% fall from April of last year.

The April 2014 report says that “NYMEX heating oil average daily volume is down over 40% from January and about 33% lower than April of last year.”

Commodity Futures Trading Commission data shows that there has been a decline in the open interest in energy products held by US banks apparently as a result of the decline in volatility.  “Financial institutions have been reducing their trading interest in low volatile energy products from December to April, while increasing their exposure to agricultural commodities and most metals,” the Platts report says.

From December through April, open interest levels held by financial institutions were flat for NYMEX crude, while open interest in heating oil and natural gas futures declined 13% and 12%, respectively.

During the same time period banks increased their open interest in CBOT Wheat futures by 33%, while the CBOT Corn contract saw a jump of over 13%.

Global crude trading activity in the Platts Market on Close, or MOC, assessment process “pulled back” in April, according to the review, though trading in the Asian MOC was described as “vibrant.”

There was a total of 142.93 million barrels of crude traded globally in the electronic window, a decline of 10.3 million barrels from April 2013. “Volume was pressured from lower trading interest in Europe, the Middle East, and Africa, or EMEA, and the Americas,” the report said.

In EMEA 54.82 million barrels were traded in April 2014, a decline of just 1.5% versus April 2013, but it was a 17.3% drop from the previous month of March 2014.

In the Americas in April 2014 there were 13.2 million barrels of crude traded in the window. This represented a 21.6% decline over April 2013, and a 12.2% decline compared to the previous month of March.

In Asia’s MOC liquidity increased in April for the second month in a row, with 74.9 million barrels traded, though liquidity in April was 7.8% lower than last April.

The Platts report said that banks represented 6.2% of all global MOC trades in April, while major oil companies accounted for 40.9% of the volume.

The independent trading houses, also referred to as the merchant traders, led by Vitol, had 52.9% of the reduced April global MOC trades.

In the Americas MOC, where liquidity was down 21.6% compared to April 2013, the merchants saw their combined share of MOC trading fall from 62% in March to 52.24% in April, according to the Platts report.

Investment bank Morgan Stanley was the most active participant in the Americas MOC in April.

Data on distillate volumes traded in the Americas MOC process showed liquidity down 15.5% compared to April 2013. Fuel oil was 62% lower than the same month last year, while LPG liquidity was 57% lower than in April 2013, the Platts report said.

Global MOC player type. Source: Platts Market Activity Report, April 2014

Global MOC player type. Source: Platts Market Activity Report, April 2014

This updated version of this post states LPG liquidity was 57% lower than in April 2013. An earlier version of the post reported the number incorrectly.

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