The future belongs to the little guys
KEEP AN EYE ON SMALL TRADERS FOCUSED ON CRUDE AND REFINED PRODUCTS THE SECOND HALF OF 2016
JAMES POTTS, OPENLINK, HOUSTON
ANYONE WHO loves rooting for the underdog should keep an eye on the US refined products market and a winning streak among tier two and three traders that looks to stretch into the second half of 2016.
That's not to say that the traditional big hitters are leaving the game, or that they're set for any particular strikeouts, but the way the market has developed in the first half of this year has levelled the playing field for smaller, more nimble competitors. Market volatility is certainly more than game, but it is the new normal in the refiner's playbook as finance finally flows to bankroll oil trades again.
As the market changes, so too do the market participants. The dominant hall-of-famers are still there, but the rookies will be the ones to keep an eye on for the rest of the year. Often these will be small trading outfits focused on crude and refined products - not necessarily new entrants to the market, but not the usual success stories either. Commonly, two or more such players will create a joint venture to pool risk and resources, which keeps them small enough to be agile and take advantage of game-changing opportunities on the horizon.
OUT WITH STABILITY, IN WITH VOLATILITY
Not so long ago, oil and related commodities were some of the most stable asset classes around. Demand was predictably and steadily high, and OPEC members cooperated to keep the price high. Equities or FX traders could only dream of such a set-up.
But then 2015 happened: oil crashed. American shale flooded the market, and OPEC refused to adjust production to maintain the pricing status quo, hoping to race the more cost-intensive shale to the bottom and reclaim market share. Suddenly, no one knew what was coming next, and volatility rocketed.
A little volatility, of course, can be a good thing. All traders need a little volatility to find opportunities. But the bigger the trader, the more they crave some stability too. Listed companies with a global footprint like Glencore have shareholders to think of and possibly dividends to pay (Glencore felt it had to suspend its own dividend payments in response to the crash). Privately owned tier-ones like Sempra Energy Trading may not be beholden to a share price, but they still have investors to placate.
Big traders are less able to take positions deemed high risk; they have to keep within a certain margin of safety. Their trading strategies are naturally conservative by design as a means to assuage a legion of risk and compliance managers.
A lot of smaller players aren't constrained in the same way. The smallest may have invested their own capital in the company, answering to no one, and external investors in smaller trading outfits tend to have a larger risk appetite to start with. They can be more flexible in terms of their trading strategies and approach to risk.
A certain portion of the market's deal flow is therefore more suited to the smaller players, and the higher risk is often commensurate with higher rewards.
Some will fail of course, and may lack the reserves to fall back on what tier-ones enjoy. Plenty will make educated bets that pay off though, and they're perfectly positioned to take the second half of 2016 by the horns.
VOLATILITY REWARDS AGILITY
It's not just their capacity to take riskier bets that benefits the little guys in these uncertain times. Also key is their agility: their ability to respond quickly to the twists and turns of an erratic market. Imagine a tier-one as one of the super-tankers its assets are shipped in: huge, impressive, but with a two-mile turning radius. By contrast, the smaller players are nimble: they can turn on a dime and respond quickly to changing events; they have much less complex portfolios and considerations to factor.
For example, when the US lifted oil export sanctions, Glencore was well-prepared and took many of the first cargoes. Good for them, but the others piling in just behind them were the tier twos and threes on a steady drive to take the lead.
GET IT ON CREDIT
Before the financial crisis, a trader in the oil and refined products space would typically have a trade finance relationship with one bank. When the crisis hit, panicked banks no longer wanted the exposure. They looked to split it where they could, or otherwise offload it. This meant less trade finance available to smaller, more highly leveraged players and more difficulty getting at what credit was available.
Banks are more stable today as the recovery continues, but more importantly, oil has climbed up to near $50 per barrel, following a crash that sank it to around $30 to $40/bbl. At this price, the capital requirements to provide credit were lower, and so too the banks' exposure to the oil and refined products market relative to their total portfolios.
This means they can take on more risk and extend more credit to finance trade deals in the sector - not really relevant to a tier-one, but of huge consequence to the smaller trading houses. They suddenly have access to a huge amount of capital to trade with, especially when sharing risk in joint ventures.
This means more is at stake for those who make losing trades, but greater returns and market share for the smartest players.
There is no reason to predict the glory days are over for tier-one energy commodity traders, but 2016 so far has given reason to be optimistic for the smaller competitors that ride the momentum of ideal conditions and grab market share. The playing field of today may not look the same tomorrow, but into the foreseeable future it's safe to bet on the little guys.
ABOUT THE AUTHOR
James Potts is Director, Americas Energy & Commodities within OpenLink's Houston office. As a specialist in Commodity Trade Risk Management (CTRM), he helps companies identify complete solutions for planning, producing, processing, managing, moving, and trading liquid hydrocarbons.