Abstract
In this chapter, we explore the considerably more challenging task of using fundamental data for generating trading signals, and the class of semi-systematic strategies, colloquially referred to as quantamentals. We discuss the convergence strategy of WTI-Brent accordion and extend the concept to construct a broader statistical arbitrage portfolio of energy pairs. We use the technique of fractionation to incorporate inventories and provide additional ideas for modeling flows and positioning.
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Notes
- 1.
Many financial speculators are required to roll their position at least five days prior to the expiration of the futures contract to avoid regulatory position limits and risks of physical delivery. The static short spread strategy is relatively insensitive to the exact rolling schedule, provided that a short position is entered prior to the scheduled index rolls.
- 2.
The choice of this metric does shorten the lookback period as Cushing capacity data is only available since 2011. However, the conclusions are substantially similar if the analysis is repeated for longer lookbacks using private estimates for the storage capacity prior to 2011.
- 3.
See Ederington et al. (2021).
- 4.
Brent futures are based on the so-called BFOET basket, which includes Brent, Forties, Oseberg, Ekofisk, and Troll, all produced in the North Sea. US Midland oil produced in the Permian Basin was added to the basket in 2023. For a detailed description of the price setting mechanism in the Brent market, we refer to Fattouh (2011). See also Imsirovic (2021).
- 5.
The USA continues to import some oil to better match refinery needs that are optimized to run on heavier crude oil. While the USA imports heavy oil, the light shale oil is exported to less complex refineries located mostly in Asia and Latin America. With the growth of shale production, US oil exports started to exceed its imports.
- 6.
In practice, arbitrage traders often shift one leg of the spread by one month to account for the shipping time. For example, to approximate the economics of oil exports from the USA to Europe, traders are more likely to use the spread between Brent futures that expire at time TÂ +Â 1 and WTI futures that expire at time T.
- 7.
The WTI-Brent convergence strategy and its sensitivity to model parameters are analyzed in Bouchouev and Zuo (2020).
- 8.
For a good introductory discussion of cointegration and its application to financial markets, we refer to Alexander (2001).
- 9.
There are, in fact, several competing US Gulf Coast WTI contracts listed by two major exchanges, CME and ICE, but for simplicity, we do not differentiate between them.
- 10.
Light and heavy oil correspond to the oil density and sweet and sour to its sulfur content.
- 11.
For illustration, we use holdings of two main futures benchmarks, WTI traded on CME and Brent traded on ICE. Adding options and other less liquid exchange-traded WTI and Brent futures does not change the conclusions.
- 12.
To simplify the exposition, we do not include positions held in refined products, such as diesel, gasoil, or RBOB. The notional size of such positions is smaller than it is for crude oil futures, even though it is comparable and sometimes even larger if measured relative to the size of the market for refined products.
- 13.
The question whether speculators or hedgers make money by trading commodity futures has been studied extensively in the academic literature but with largely inconclusive results. Given the complexity of differentiating between hedgers and speculators in the oil market and the lack of available data, establishing such a causality using purely statistical tools is extremely difficult. One interesting attempt to separate the impact of hedgers and speculators on prices by the investment horizon was made by Kang et al. (2020) for a broader commodity portfolio.
References
Alexander, C. (2001). Market models. Wiley.
Bouchouev, I., & Zuo, L. (2020, Winter). Oil risk premia under changing regimes. Global Commodities Applied Research Digest, 5(2), 49–59.
Ederington, L. H., Fernando, C. S., Holland, K. V., Lee, T. K., & Linn, S. C. (2021). The dynamics of arbitrage. Journal of Financial and Quantitative Analysis, 56(4), 1350–1380.
Fattouh, B. (2011). An anatomy of the crude oil pricing system. Oxford Institute for Energy Studies, Working Paper, 40.
Imsirovic, A. (2021). Trading and price discovery for crude oils: Growth and development of international oil markets. Palgrave Macmillan.
Kang, W., Rouwenhorst, K. G., & Tang, K. (2020). A tale of two premiums: The role of hedgers and speculators in commodity futures markets. The Journal of Finance, 75(1), 377–417.
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Bouchouev, I. (2023). Quantamentals. In: Virtual Barrels. Springer Texts in Business and Economics. Springer, Cham. https://doi.org/10.1007/978-3-031-36151-7_6
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DOI: https://doi.org/10.1007/978-3-031-36151-7_6
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