PEAK PESSIMISM: Everyone seems to think crude is going lower

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It has been a terrible year for crude oil. Despite a tentative bounce overnight, Brent crude has fallen by more than 36% so far in 2015, leaving the global benchmark price down more than 68% from mid-2014.

It now sits at levels last seen 11 years ago and, if the options market is anything to go by, speculators and oil producers themselves don’t expect the price to recover anytime soon.

According to Bloomberg, investors are betting in ever-increasing numbers that the crude price will continue to slide in the year ahead, weighed down by OPEC’s effective scrapping of output limits, Iran’s anticipated return to the market and the resilience of production from countries such as Russia and the United States.

The pessimistic outlook has seen investors lining up to bet on (or to hedge against) further price declines. Recent data from the New York Mercantile Exchange and the US Depository Trust & Clearing Corporation reveals investors have been buying put options over the US benchmark oil price – WTI – as low as $15 a barrel next year.

A put option provides the holder the right, but not the obligation, to sell at a predetermined price at a future date. It can be used to speculate on future price movements, or for producers to hedge against further price declines for their products, akin to taking out insurance.

The largest open interest across all option contracts is for puts at $30 a barrel that expire in December 2016, representing a further decline of close to 18% from the current spot price of around $36.50 a barrel.

In a research report released yesterday, Jeffrey Currie, head of commodities research at Goldman Sachs, wrote that the glut in oil markets – resulting from increased output hitting the market at a time when demand remains soft – was likely to continue “well into next year”.

The remarks follow a note from the bank released earlier this month in which they stated that there were “high risks” that mild weather in the northern hemisphere, slowing emerging market growth, burgeoning inventory levels and a resumption of supply from Iran could see oil supply breach current storage capacity, increasing the risk that crude could drop to as low as $20 a barrel in response.

It’s not only investment banks that suggest risks remain to the downside. According to The Australian, Sydney-based Origin Energy has taken action to mitigate financial risks that may eventuate from further declines in the crude price.

The Australian-listed energy firm will spend $A82 million on put options on 15 million barrels of oil at $40 a barrel, covering most of the oil price-linked liquified natural gas (LNG) sales from the Australia Pacific LNG plant it is building in Queensland.

The Australian calculates that the company now has a floor price of $40 on nearly all of its sales from the plant in 2016-17 financial year, providing protection from further price declines and exposure to price gains should crude stage an unlikely rebound.

“We’re in a position where we have to take off the table the question, ‘what if they keep falling and what if they are lower for longer’,” Mr King told The Australian yesterday.

“We ultimately concluded that the certainty of $A82m to take a hugely unknown risk off the table was worth doing … by putting strikes in at $40, we said even if it’s $20, it’s limited, even if it’s $US10, it’s limited.”

While contrarian investors may deem such action from a major energy producer as a sign that a price rebound could ensue, it’s clear that fundamentals, markets and sentiment, continue to suggest there’s likely to be more pain for the crude price in the months ahead.

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