Events in the Middle East strongly influence price behavior in the Brent crude market and the recent instability in Iraq has caused some substantial price swings.
As the chart below shows, Brent was stuck in a range-bound pattern from July 2013 to June 2014. Although trends existed for a few days, in general the market favored “mean reversion” strategies during this period. Traders whose preferred style is long-term trend following may be forgiven if they had given up on the crude markets in the past twelve months.
If a trader was still persevering with trend following then the period from June 5 to July 15 ,2014 would have rewarded that patience, as the market saw 10 consecutive days of increasing prices, then a day of little movement, followed by 15 consecutive days of falling prices.
The fall was somewhat elegant from a technical point of view because we saw a near perfect series of lower highs and lower lows each day during this period. The technicals even offered a warning flag that the bottom might be near in the form of the 200 day moving average for the September contract.
What was the cause of the recent price action?
June 12 saw a three dollar rally as news broke that, having taken Mosul, rebels were progressing southward towards Baghdad. As their strength became apparent the prospect of disruption to the southern oilfields became real and prices continued to rally for another five days. From June 23 ,the 15 day series of declining prices began.
The timing of this reversal seemed premature because at this point the crisis in Iraq was far from resolved and fundamental traders may well have felt the higher prices were still justified, but the technicals were clear as the series of lower highs and lower lows began. As often seems to occur, the fundamental news emerged to fit the chart. Baghdad did not fall, the southern oilfields were safe for now, Libya unexpectedly announced the resumption of exports, West African cargoes remained unsold and tight diesel margins in Europe restrained the appetite of the refiners.
Other Brent Trends
Another significant trend gaining attention is the shift of volume in the Brent market to CME Group’s NYMEX Brent contract.
Liquidity has been growing steadily since CME re-launched NYMEX Brent at the beginning of 2013, with open interest now over 100,000 contracts and having achieved a record day of 151,235 contracts traded on July 15 . This growth is illustrated in the chart below.
The attractiveness of NYMEX Brent stems from a few factors:
First, screen trading of NYMEX Brent is FREE (i.e. there are no exchange fees). Exchange fees can make up a significant portion of execution costs, particularly when trading time spreads and butterflies, so the advantage of switching to an identical product that is cheaper to trade is clear.
Secondly, the majority of professional oil traders will hold most of their positions as spreads. Popular inter-product spreads include spreading Brent against WTI or DME Oman crude and crack spreads against RBOB (Gasoline) or ULSD (Diesel). Traders who hold both legs at CME Group will see their initial margins discounted by 70-90 percent, which reduces capital costs and/or enables holding larger positions than would otherwise have been possible.
Thirdly, CME offers spread products that eliminate legging risk – not being able to fill one leg of a spread – and maximize the chances of the order being filled at the best level. CLBZ (WTI-Brent), BZOQD (Brent-Oman), RBBZ (RBOB-Brent) and HOBZ (ULSD-Brent) are pre-configured spreads that enable hassle-free execution and confidence that the implied engine will execute the order at the best level without the risk of getting legged in the event of sudden market movements.
Looking to the future, the launch of the Shanghai Crude Oil contract will dovetail with the DME Oman Crude Oil contract. Traders with an interest in the Chinese crude markets have noted that the Shanghai contract will open up financial and physical arbitrage opportunities to DME Oman, which trades on CME Group’s Globex platform. Thus traders may find it convenient to have their NYMEX WTI, NYMEX Brent and DME Oman crude oil positions together on one platform.