Crude oil producers and money managers recently increased financial exposure to crude oil prices
In early 2021, West Texas Intermediate (WTI) crude oil futures and options open interest (number of contracts outstanding) increased as crude oil prices and global oil production and consumption rose. According to the Commodity Futures Trading Commission’s (CFTC) Commitments of Traders (COT) report, market participants in the producer/merchant category, which includes upstream producers, refiners, terminal operators, and other physical market participants, contributed significantly to the increase in open interest in the first quarter of 2021 (1Q21). The total producer/merchant contracts held peaked at 1.45 million contracts on June 15 before decreasing, driven by a drop in short positions, likely in response to revised hedging strategies from upstream producers. Initiating a short position includes selling a futures contract, selling a call option, or buying a put option, and it allows the holder to lock in a future price for a commodity today, which oil producers and end users can use as a way to hedge or mitigate price risk. Conversely, a long position includes buying a futures contract, buying a call option, or selling a put option, allowing the holder to benefit from a price increase in the future. Total contracts held by money managers (which includes bankers and financial fiduciaries) also decreased in July and August before beginning to increase again in early September at the same time as nominal crude oil prices began increasing to highs not seen since 2014.
Crude oil and other commodities are traded on futures markets, which are exchanges that market participants can use to manage risk associated with price uncertainty in a variety of businesses, including upstream crude oil production, refining, shipping, and portfolio management. Futures markets play a role in crude oil price discovery, and futures markets are essential to the ability of crude oil producers and end users to manage the risk associated with uncertain crude oil prices. The CFTC’s COT report lists the aggregate positions of all market participants within CFTC’s designated categories that engage in buying and selling of WTI futures, as well as financial options that are converted into futures-equivalent contracts. The CFTC’s producer/merchant category reflects entities that predominantly engage in the production, processing, or handling of a physical commodity and tend to use the futures markets to manage or hedge risks associated with those activities. Unlike producer/merchant open interest, the CFTC’s money manager open interest category represents positions taken by financial market participants, such as funds and commodity traders, rather than market participants engaged in the physical buying or selling of crude oil as their primary business.
Since mid-August 2021, trends in the COT report show a decrease in WTI short positions held by producers and merchants, leading to a shift to an overall net long position (more long positions than short positions) for this trader category (Figure 1). Total contracts held among producers and merchants in WTI futures and options averaged 1.20 million contracts in 1Q21, an increase of 0.27 million contracts over 4Q20. Total contracts held increased to 1.36 million contracts in 2Q21 before declining to an average of 1.15 million contracts in 3Q21. Starting in August, positions shifted to a net long position for the first time since April 2020 and reached the highest net long position since September 2019. Typically, the net producer/merchant position is short because producers often use a greater number of short contracts as a financial hedge against declining prices.
An analysis of financial disclosures from 75 publicly traded U.S. producers shows hedging activity increased starting in 2Q20 because of volatility in WTI prices caused by the COVID-19 pandemic. Hedging of total crude oil and natural gas liquids (NGL) field production by these 75 U.S. upstream companies reached nearly 72% of their collective production in 2Q20 compared with the 2017–19 average of 41% (Figure 2). These 75 firms accounted for 35% of total U.S. crude oil/NGL field production in 2Q21. These observations do not represent the U.S. upstream sector as a whole because the analysis excludes private companies that do not publish financial reports and some public firms that do not engage in financial hedging.
Hedging allows producers to mitigate financial losses due to lower sales prices if prices decline, but generate financial losses (offset by physical sales) if prices rise higher than the level at which they sold production forward. As WTI prices increased in 2021, crude oil producers gained increasing revenues on crude oil barrels sold into the market. However, the price difference between barrels sold at the market rate and barrels that had been hedged also increased. Upstream producers—including Devon Energy, Diamondback, and Ovintiv—reported some financial losses in their second-quarter financial filings because of hedging at around $50 per barrel (b). Because WTI crude oil spot prices averaged $66/b for 2Q21, these companies reported financial losses on their hedged barrels, usually of around $13/b compared with unhedged barrels. The difference between the prices of hedged barrels and the market price of crude oil in 2Q21 may have provided some incentive for some crude oil producers to reduce hedging beginning in 3Q21, potentially contributing to fewer net short position of contracts held by producers and merchants.
In the money manager category of the COT report, net long positions have increased since early September 2021 (Figure 3). Open interest from money managers typically reflects market participants who are investing in crude oil to gain financial exposure (a position in which they benefit from price increases) to commodities as an asset class. As a result, money manager open interest in crude oil futures leans toward a net long position, reflecting a financial position that increases in value when crude oil prices increase.
Rising crude oil prices near the beginning of 2021 contributed to an increase in total WTI futures and options contracts held by money managers, which averaged 475,000 contracts in 1Q21, an increase of 20,000 contracts over 4Q20. The money manager aggregate position also shifted from an average net long position of 312,000 contracts in 4Q20 to 370,000 contracts in 1Q21. Overall contracts held from money managers decreased in the second quarter to 457,000 contracts, but the net long position increased to an average of 382,000 contracts as high crude oil prices and increased economic growth likely supported money managers’ financial exposure to crude oil and other commodities.
Since reaching a 2021 low of 376,000 contracts on August 17, total contracts held by money managers in WTI futures and options have increased by 27,000 contracts (about 7%), and the net long position of money managers has increased from 280,000 contracts on August 17 to 341,000 contracts as of October 26. The net long position for money managers remains less than it was during the summer, but it has increased with relative consistency since early September. Increasing money manager open interest correlates with increasing global crude oil prices. The WTI front-month futures price increased from just over $69/b in early September to $84/b on October 29, an increase of 22%. Crude oil prices have been relatively high through much of 2021, but the October prices mark the year’s highest price levels and crude oil’s highest nominal price since 2014.
Money managers could be increasing financial exposure to crude oil and other commodities as a way to mitigate financial risks from increased inflation. Among other macroeconomic factors, increasing crude oil prices have contributed to increased inflation expectations in financial markets, as observed by the difference between the yield on the five-year U.S. Treasury Bond and the Treasury Inflation Protected Security (TIPS) (Figure 4). Price increases because of supply chain constraints, combined with an increasing energy component of the Consumer Price Index (a key inflation indicator), underscore some of these concerns and put pressure on money managers to pursue investments that will maintain value should inflation continue. As the TIPS-Treasury spread increases, this trend indicates market participants expect impending inflation (although it does not indicate a corresponding change in actual inflation). As of October 29, the TIPS-Treasury spread had increased to nearly 2.9%, an increase of 0.41 percentage points from the beginning of September and its highest level in 2021.
U.S. average regular gasoline and diesel prices increase
The U.S. average regular gasoline retail price increased nearly 1 cent to $3.39 per gallon on November 1, $1.28 higher than a year ago. The West Coast price increased by nearly 4 cents to $4.10 per gallon, the East Coast price increased by nearly 1 cent, remaining virtually unchanged $3.34 per gallon, and the Gulf Coast prices increased by nearly 1 cent to $3.07 per gallon. The Midwest price decreased by less than 1 cent to $3.21 per gallon, and the Rocky Mountain price decreased by less than 1 cent, remaining virtually unchanged at $3.56 per gallon.
The U.S. average diesel fuel price increased more than 1 cent to $3.73 per gallon on November 1, $1.36 higher than a year ago. The West Coast price increased nearly 5 cents to $4.32 per gallon, the Rocky Mountain price increased nearly 4 cents to $3.81 per gallon, the East Coast price increased more than 1 cent to $3.72 per gallon, the Midwest price increased nearly 1 cent to $3.64 per gallon, and the Gulf Coast price increased less than 1 cent to $3.49 per gallon.
Propane/propylene inventories rise
U.S. propane/propylene stocks increased by 0.4 million barrels last week to 76.1 million barrels as of October 29, 2021, 12.4 million barrels (14.1%) less than the five-year (2016-2020) average inventory levels for this same time of year. East Coast and Midwest inventories increased by 0.6 million barrels and 0.4 million barrels, respectively. Gulf Coast inventories decreased by 0.5 million barrels, and Rocky Mountain/West Coast inventories decreased slightly, remaining virtually unchanged.
Residential heating oil prices decrease, propane prices increase
As of November 1, 2021, residential heating oil prices averaged more than $3.39 per gallon, almost 1 cent per gallon below last week’s price but more than $1.26 per gallon higher than last year’s price at this time. Wholesale heating oil prices averaged nearly $2.60 per gallon, 6 cents per gallon below last week’s price but more than $1.41 per gallon above last year’s price.
Residential propane prices averaged $2.72 per gallon, almost 1 cent per gallon above last week’s price and nearly 90 cents per gallon above last year’s price. Wholesale propane prices averaged almost $1.54 per gallon, nearly 3 cents per gallon below last week’s price but more than 85 cents per gallon above last year’s price.
For questions about This Week in Petroleum, contact the Petroleum Markets Team at 202-586-4522.