Energy Commodity Markets from a Practical Perspective
July 5, 2012
Tim Simard
NBC Commodities
• 14-person Calgary-based team running both a client-driven and strategic trading operation
• Largest trader of financial energy derivatives among Canadian banks
– Collective team experience in excess of 250 years in the field of energy trading and risk
management
– strategic trading activities largely to support client-driven business
– Energy capabilities: crude oil, refined products and both physical and financial natural gas
• OTC swaps and broad range of options
– first Canadian bank providing WCS (Canadian heavy crude), Edmonton Sweet and NGL
risk management structures
• Broad base of corporate flow hedging activity
– 75% oil and gas producers along with midstream companies, utilities and energy consumers
• Strong lending franchise supports energy hedging business
• 150+ transactional clients over the past 12 months
• Well-received daily commentary circulated to over 1,500 people
• Trading desks provide the hedge for all the Horizons AlphaPro & BetaPro commodity ETFs:
– Crude, natural gas, gold, silver, copper
– Execution and warehousing counterparty to physically-backed Australian gold ETF
– Participated in the design mechanics of HBP single- and inverse energy ETFs
• Broad contact with institutional investors, providing market updates and offensive/defensive direct
commodity trade ideas
July 2012
2
What Drives Corporate Hedging Activity?
• Hong & Yogo:
• “producers are infinitely risk-averse and would like to hedge all
uncertainty about the spot price.”
– As they anticipate more demand for their product, they will sell more
futures and open interest will rise
• Acharaya, Lochster and Ramadorai:
• “when firm-specific default risk is high, commodity producers are
more likely to hedge”
• Difficult to see this in practice in the energy sector
• (i) producers are geared to increase their production even if
economic indications suggest tepid demand for their product
• (ii) investors want the commodity price upside (???)
• (iii) price view is a primary driver of hedging activity
– More likely to hedge when the price prospects are weak
July 2012
3
Producer Activity – Crude Oil
•
Surge in activity late last year and early this year based on (i) absolute price levels; (ii) budget timing; (iii)
unwillingness to hedge gas; (iv) gas experience; (v) risk perceptions
NBC Relative Monthly Producer Volumes
July 2012
May-12
Mar-12
Jan-12
Nov-11
Sep-11
Jul-11
$40.00
May-11
0.0%
Mar-11
$50.00
Jan-11
1.0%
Nov-10
$60.00
Sep-10
2.0%
Jul-10
$70.00
May-10
3.0%
Mar-10
$80.00
Jan-10
4.0%
Nov-09
$90.00
Sep-09
5.0%
Jul-09
$100.00
May-09
6.0%
Mar-09
$110.00
Jan-09
7.0%
Nov-08
$120.00
Sep-08
8.0%
Jul-08
$130.00
May-08
9.0%
Mar-08
$140.00
Jan-08
10.0%
NYMEX USD WTI One-Year Strip
Relative Volume
Crude Oil Hedging Volumes versus One-Year NYMEX WTI Strip
January 2008 - May 2012 (53 Months)
1-Year NYMEX WTI Strip
4
Producer Activity – Natural Gas
Relative Monthly NBC Producer Client Hedge Volumes versus AECO Forward Price
Jan 2008 - May 2012 (53 Months)
8%
$16.00
Relative Monthly Producer Hedge Volumes
7%
$14.00
Monthly Average AECO 1-Year Forward Strip
July 2012
May-12
Mar-12
Jan-12
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Nov-10
Sep-10
Jul-10
May-10
Mar-10
$Jan-10
0%
Nov-09
$2.00
Sep-09
1%
Jul-09
$4.00
May-09
2%
Mar-09
$6.00
Jan-09
3%
Nov-08
$8.00
Sep-08
4%
Jul-08
$10.00
May-08
5%
Mar-08
$12.00
Jan-08
6%
5
Comparative Large Gas Producer Hedge Positions
•
NYMEX pricing for 2010 during December 2009: $5.65 per MMBtu
•
NYMEX pricing for 2012 during December 2011: $3.51 per MMBtu
End-of-2009 Hedge Positions
Anadarko Petroleum
Apache Corp
Cenovus
Chesapeake Energy
Devon Energy
EnCana Corp.
EOG Resources
Newfield Exploration
Noble Energy
Southwestern Energy
Talisman Energy
Ultra Petroleum
Total Production
Weighted Hedge Percentage
•
Estimated 2010
North American % 2010 % 2011
Production Bcf/d Hedged Hedged
2.217
78%
26%
1.025
1%
0%
0.749
58%
8%
2.492
61%
8%
2.650
51%
0%
3.070
60%
21%
1.358
1%
0%
0.547
70%
50%
0.405
64%
19%
1.020
16%
7%
1.320
34%
1%
0.527
51%
41%
17.380
48%
12%
End-of-2011 Hedge Positions
Estimated 2012
%
North American Hedged % Hedged
Production Bcf/d
2012
2013
Anadarko Petroleum
2.328
43%
19%
Apache Corp
1.493
22%
3%
Cenovus
0.619
42%
27%
Chesapeake Energy
2.956
0%
0%
Devon Energy
2.655
31%
0%
EnCana Corp.
3.459
65%
16%
EOG Resources
1.245
42%
12%
Newfield Exploration
0.479
58%
35%
Noble Energy
0.432
42%
42%
Southwestern Energy
1.448
50%
35%
Talisman Energy
0.854
0%
0%
Ultra Petroleum
0.702
79%
0%
Total Production
18.67
Weighted Hedge Percentage
36%
12%
Even if one excludes Chesapeake, 46% hedged for 2010, 42% hedged for 2012
July 2012
6
Price View or Default Risk?
•
“The amount of production we hedge is driven by the amount of debt on our balance sheet and the level of capital
commitments we have in place.” St. Mary Land & Exploration Co. (90,000 BOE/d)
•
Chesapeake (600,000 BOE/d):
July 2012
7
Price View or Default Risk?
•
Figure 3 from Achara et. al.:
July 2012
8
Canadian Energy Producer Hedge Process in Practice
• Reluctant to hedge given perception of shareholder desire for commodity
price exposure
• willingness to maintain very conservative debt levels in order to survive
cyclical downturns
– Differentiation from US producers
• Incentive to hedge most often driven by desire to fund capex growth
profile and/or maintain distributions
– Less around default risk
– Hedging can allow for incremental lending capacity in times of high
prices
• If forward prices are at or above management/board expectations, hedge
positions are added
– Hedging seldom occurs when management believes the price is
going to rise
• Much easier for producers to sell into a contango market than a
backwardated market, but absolute price levels more important than the
forward premium or discount
July 2012
9
Price Decks & Forward Curves: CAD WTI Crude
NBC Lending CAD WTI Price Deck Versus Forward Price
July 3, 2012
$88
$88.94
$88.49
$89.00
$87
$87.10
CAD per Bbl
$86
$86.00
$85
$85.00
$85.00
$84
Price deck on average over the next 4
years is 5% below the forward curve.
$83
$82
$82.00
$81
$80
2012
2013
2014
NBC Price Deck - Apr 2012
July 2012
2015
Forward Curve
10
Risk Aversion Impact of Management Teams
• Viral et. al. discussion of risk-averse vs. risk-tolerant managers
based on share ownership vs. option ownership
– 20% more likely that managers tilted toward share
compensation will hedge
• Certainly makes sense from a theoretical perspective
– If you were simply long options, why undertake management
decisions that serve to reduce the volatility of the underlying?
• Lower volatility = lower option value
• Have not done any empirical studies on this effect in the Canadian
energy sector but would be very interested to see the results!
July 2012
11
Investor Issues: Impact on Crude Forward Curve Structure
12th Month Forward WTI - Prompt WTI Spread
From Jan 1990 - Dec 2004, in contango only 29% of the time
Since Jan 2005, over 80%
of the time
$25.00
Investors in the
market.
$20.00
$15.00
CONTANGO
$10.00
$5.00
$-
$(5.00)
$(10.00)
BACKWARDATION
Jan-90
Jul-90
Jan-91
Jul-91
Jan-92
Jul-92
Jan-93
Jul-93
Jan-94
Jul-94
Jan-95
Jul-95
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
$(15.00)
July 2012
12
Index Investments in Oil
Crude-Equivalent Barrels
CL + RBOB + HO Barrels
July 2012
Apr-12
Feb-12
Dec-11
Oct-11
Aug-11
Jun-11
Apr-11
Feb-11
Dec-10
$20
Oct-10
0
Aug-10
$40
Jun-10
100
Apr-10
$60
Feb-10
200
Dec-09
$80
Oct-09
300
Aug-09
$100
Jun-09
400
Apr-09
$120
Feb-09
500
Dec-08
$140
Oct-08
600
Aug-08
$160
Jun-08
700
USD per Bbl
Million Bbls
Barrels Underlying Index Funds vs. WTI Price
Source: CFTC
WTI
13
Index Investments in Natural Gas
6
$14
5.5
$13
5
$12
4.5
$11
4
$10
NYMEX NG Tcf
July 2012
Apr-12
Feb-12
Dec-11
Oct-11
Aug-11
Jun-11
Apr-11
Feb-11
Dec-10
$2
Oct-10
0
Aug-10
$3
Jun-10
0.5
Apr-10
$4
Feb-10
1
Dec-09
$5
Oct-09
1.5
Aug-09
$6
Jun-09
2
Apr-09
$7
Feb-09
2.5
Dec-08
$8
Oct-08
3
Aug-08
$9
Jun-08
3.5
USD per MMBtu
Tcf
Tcf Underlying Index Funds vs. NYMEX NG Price
Source: CFTC
NYMEX NG
14
ETF Players Exacerbating Market Volatility: NO!!
Total Crude Oil ETF Contracts versus Prompt WTI
130,000
$150.00
Escalation in
Price, ETF
Redemptions
120,000
110,000
Escalation in
Price, ETF
Redemptions
$140.00
$130.00
100,000
$120.00
90,000
$110.00
80,000
$100.00
70,000
$90.00
60,000
$80.00
50,000
$70.00
Escalation in
40,000 Price, NO ETF
Creation
30,000
$60.00
$50.00
20,000
$40.00
10,000
$30.00
$1.6 billion of redemptions
Net Position: USO + HOU - HOD
July 2012
Jun-12
Apr-12
Feb-12
Dec-11
Oct-11
Aug-11
Jun-11
Apr-11
Feb-11
Dec-10
Oct-10
Aug-10
Jun-10
Apr-10
Feb-10
Nov-09
Sep-09
Jul-09
Jun-09
Apr-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
$20.00
Mar-08
0
Jan-08
Futures Contract Equivalent
$160.00
Price Collapse,
ETF Creation
USD per bbl
140,000
Prompt Month WTI
15
ETF Investors in the Gas Market
Total Natural Gas ETF Contracts versus Prompt NYMEX NG
Every time the prompt NYMEX
NG contract fell below $4.00,
we used to see massive ETF
capital inflows…but nothing
over the past year
160,000
150,000
140,000
$15.00
$14.00
$13.00
120,000
$12.00
110,000
$11.00
100,000
$10.00
90,000
$9.00
80,000
$8.00
70,000
$7.00
60,000
$6.00
50,000
$5.00
40,000
$4.00
30,000
$3.00
20,000
$2.00
10,000
$1.00
Net Position: UNG + HNU - HND
July 2012
Jun-12
Apr-12
Feb-12
Dec-11
Oct-11
Aug-11
Jun-11
Apr-11
Feb-11
Dec-10
Oct-10
Aug-10
Jun-10
Apr-10
Feb-10
Nov-09
Sep-09
Jul-09
Jun-09
Apr-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
$-
Jan-08
0
USD per MMBtu
Futures Contract Equivalent
130,000
$16.00
Prompt Month NYMEX NG
16
Horizons Crude Bull & Bear Net Assets Under Management
•
ETF investors have a propensity to turn from buyers to sellers when WTI makes its way over $100
($0.10)
$60
($0.20)
$50
($0.30)
$40
($0.40)
$30
NET HOU and HOD AUM
July 2012
Apr-12
$70
Jan-12
$0.00
Oct-11
$80
Jul-11
$0.10
Apr-11
$90
Jan-11
$0.20
Oct-10
$100
Jul-10
$0.30
Apr-10
$110
Jan-10
$0.40
Oct-09
$120
Jul-09
$0.50
Apr-09
$130
Jan-09
$0.60
Oct-08
$140
Jul-08
$0.70
Apr-08
$150
Jan-08
$0.80
USD per Bbl
CAD Billion
Net HOU and HOD AUM vs WTI
Spot NYMEX WTI
17
Comments on Investor Impact
• No evidence from recent index investment flows/ETFs that investors are
causing market volatility
– In fact it is easier to argue the opposite
• With most of the massive passive money now in the market, main effect
is to increase contango in commodity markets
– Investors have to sell the near month and buy the deferred month on
a regular basis
• Serves to relatively depress the spot price paid by consumers, while
increasing forward prices
– Sends signals to producers to add production and consumers to
curtail consumption
• Major influx of new investor money seems to appear in low-price
environment
– Are we that worse off that investors stampede into oil and gas
markets when we move to very low price environments?
• Again, it staves off future shortages and reduces volatility
July 2012
18
Energy Commodity Markets from a Practical Perspective
July 5, 2012
Tim Simard
Disclaimer
• National Bank of Canada and its affiliates act solely in the capacity of an arm’s length
contractual counterparty and not as an adviser or fiduciary. Accordingly you should
not regard transaction proposals or other written or oral communications from us as
a recommendation or advice that a transaction is appropriate for you or meets your
financial objectives. Any financial transaction involves a variety of potentially
significant risks and issues. Before entering into any financial transaction, you should
ensure that you fully understand the terms and have evaluated the risks and
determined that the transaction is appropriate for you in all respects. You should
consult appropriate financial and legal advisers before entering into the transaction.
The indications provided above reflect the subjective opinion of National Bank of
Canada on the date(s) indicated, based on then prevailing market conditions. The
prices indicated above may not reflect the actual prices at which any transaction can
be executed, liquidated, unwound or replaced. It also does not include adjustments
for, among other things, credit spreads, cost of carry, use of capital and profit; and
may differ from National Bank of Canada’s own internal pricing for books and records
and similar purposes. This information is provided as a courtesy for information
purposes only by National Bank of Canada, subject to the understanding that the
National Bank of Canada and its affiliates are not liable for any damages, including
any loss of profits, which may directly or indirectly result from any reliance on such
information.
July 2012
20