Oil Futures and physical market – Europe impact.

Oil traders and Investors agree that the demand for oil in Europe is currently weak. However, we are seeing dramatic highs for the European physical oil market.  In striking signs of physical market tightness, the Ural crude oil, low quality oil from Russia, has jumped dramatically to record premiums.  Brent, for immediate delivery, has surged to $3.20 a barrel, one of the highest in past 20 years.

              The high volatility is mainly due to the low availability of high quality, low sulphur crude available from Libya and anywhere else.  This oil is most sought after by European refiners because of the low sulphur content, which helps them to meet the strict environment regulations. Oil traders contend that the demand weakness in Europe and potential slowdown concerns are concealing the regional supply problems. 

              The supply drop has been eminent. European and Medeterrian Oil, which groups worlds top 10 oil importers such as germany, france, spain & Italy, has seen acute shortage of high quality oil. This has forced regional refiners to draw down stocks. IEA (International Energy agency) estimates that, at about 310m barrels, they are 10% below the 5 yr average.

                Libya, another of the main culprit, has produced 700,000 b/d less than in the same period in 2010. The second cause is North Sea, where production dropped 260,000 b/d in first half due to natural depletion of mature oil fields and production glitches (Buzzard field). Oil production in Azerbaijan was down 110,000 b/d due to planned maintenance in ACG oilfield in Caspian Sea. This caused Azeri Light, a high quality oil compared to Brent, to surge by 5$ a barrel, strongest in recent history. Angola production has been running low due to repair work at BP – operated oil fields (Plutonia).  

                The tight supply however cannot go on forever. The routine supply from Libya resumes and regional demand weakens that at some point of time will loosen the physical European markets.

Foreign Exchange Market demystified

Foreign exchange market is one of the largest structures bypassing the equity market in the world. An estimate of $3.2 trillion of turnover, on average, takes place in the currency OTC market, which is truly a 24 by 7 market.

The OTC market is also known as the “spot”, “cash”, or “off-exchange” forex market. (A spot transaction refers to an exchange of currencies at the prevailing market rate.) Similarly, the forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.

Each country, through varying mechanisms, manages the value of its currency. As part of this function, it determines the exchange rate regime that will apply to its currency. For example, the currency may be free-floating, pegged or fixed, or a hybrid.

Devaluation, in common modern usage, specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency. In contrast, depreciation is used for the unofficial decrease in the exchange rate in a floating exchange rate system. 

The basic principle of depreciation (and its opposite - appreciation) is that country’s currency decreases in value relative to the foreign currencies (e.g. 1USD = 46INR now IUSD = 50INR). This make’s the country’s currency more competitive, as the price of country’s goods/services when exchanged for the foreign currency will be cheaper i.e. it will increase exports. In case of currency appreciation, the country’s currency will be less competitive, as it will take less currency to purchase a foreign currency. Consequently, it will lead to larger import of foreign goods in the country and less exports.   



http://www.rediff.com/business/slide-show/slide-show-1-perfin-explained-why-gold-prices-are-falling-now/20110927.htm

Feds reel back into growth track!

       In a positive effort to bolster the economy, the US federal reserve initiated “Operation Twist”, a $400M buyback of long dated treasury securities and send short dated securities in order to drive down the long term interest rates and ensure growth.

       Bank of England, in the minutes of September monetary policies, also indicated a second round of qunatative easing (QE) was on cards in order to stimulate the economy, which currently has a bleak GDP growth of 1.3% as per IMF’s recent report.

China - Red dragon saviour ?

          There is great anticipation that China can play a major role in de-escalating the Euro crisis. With billion in foreign reserves, China can truly enter the big stage where international financial community can acknowledge its prowess.

           However, there is political caution exercised by China by not committing itself to the cause of helping in the EuroZone affair. Although it is in China’s benefit for a stable Euro due to the “dollar trap” situation -almost $3,200 billion of foreign reserves are in dollar denomination,  China can also understand that the current grim situation in the Eurozone has to do more with the compulsions of the political will rather than the monetary situation.  Therefore it looks all China can offer at the moment is a symbolic gesture of help rather than substantive financial assistance.

Exchange Traded Funds - An Enigma

I read a recent article on FT, where a rogue trader in the reputed swiss bank, managed to cause a loss of GBP2.3bn to the aforementioned bank. The scandalous expose was yet another series of events, post the sub prime mortgages crisis that led heavy write-downs for this bank, which has shaken the confidence of investors in the financial services.

The act occurred in the complex trading activity managed in the Delta one division of UBS. The modus operandi involves heavy buying and selling of Exchange traded funds, and subsequently offsetting the risk by hedging. Delta one sits in a unique position between propriety trading – trading for banks own account - and the normal “flow” businesses, created by making trades on behalf of clients.

The rogue trader, who was familiar with the trade settlement and the book keeping process in the back office for such transactions, managed to take unauthorised “speculative” positions in some of the key ETF’s such as SP 500, DAX and Euro Stoxx without proper assessment of hedging against the risk. In the normal course of events, the bank has sufficient trigger checks to invalidate such risk positions by automatically setting or offsetting the risks.

However, as the trader had sufficient knowledge on how the settlements of such trade take place, he managed to fake offsetting hedges to hide the losses.

 

It is yet to be seen how this bank, which was in news for its corporate restructuring and some controversial labour management acts, will be able to rise from this debacle.