This article first appeared in Global Banking and Finance Review –

Oil price movements seen between the outbreak of COVID and the Russian invasion of Ukraine were sharper than at any time in the past 70 years, with levels of market volatility at their highest in at least 15 years. This has exacerbated challenges already present in the marketplace, while boosting the value of substantial product-specific data for fine tuning and maximising trading and hedging strategies through the oil swaps market.

A good illustration of the extent of the recent volatility is that in April 2020, expected 30-day volatility briefly topped 500% by one measure and spent nearly two months above 100%, far higher than the usual 30%-40%.[1] Only this year has it dropped back to a more normal level.

Rising prices, such as that of Brent crude, from a low of $20.37 per barrel in April 2020 to $118.87 in March 2022[2] and the ongoing gyrations in the market since then have been very difficult to manage. These are futures prices, which offer a level of transparency, but the lion’s share of the trading, particularly hedging, is done in the OTC market.

The volatility illustrates the price risks involved for both producers and consumers. It highlights the need to hedge effectively against adverse price movements and that’s where an increasingly sophisticated swaps market and associated market data can play a major role.

Bringing transparency to OTC markets

Historical, high-quality and bespoke pre-trade data, such as that provided by TraditionData, can help illuminate the inner workings of the market. Accurate price discovery necessitates understanding current market conditions through their historical context, not merely following short-term market movements. This underpins the foundations of successful trading: discovering new profitable opportunities, reducing transactions costs, and implementing more robust risk management.

OTC markets are less transparent. So, for the oil swaps market to function well and for players to get an edge, the need for accurate data, based on real execution, liquidity, and a high level of transactions is extremely important, particularly now as governments and business to budget for their future requirements.

Perhaps understandably, some will ask why it is necessary to expose yourself to the risks of such price movement when renewables, such as solar and wind, can offer a far safer and more sustainable solution, particularly as the world seeks to decarbonize. Indeed, providers such as TraditionData offer energy datasets on environmental products, as well as those related to fossil fuels, helping customers to gain visibility into illiquid and opaque markets, drawing on insights from Tradition’s globally recognised OTC broking desks.   

However, there’s no escaping – for now at least – the fact that fossil fuels will continue to have an important part to play in the global energy structure over the coming few decades. So, mitigating risk with effective hedging against adverse price movements is essential.

Swaps more popular than futures markets for hedging

The oil price shocks of the 1970s are dwarfed by the current price movements. At that time there were no oil futures markets that could be used for hedging purposes. The markets are far more developed now, with oil and natural gas futures traded on ICE and Nymex, bringing price transparency and liquidity to the market while offering a vehicle for hedging.

But these futures contracts are not entirely perfect for those in the oil market. For a start, they deal with specific grades of the product, which means they may not match hedgers’ needs. As well, futures contracts have restrictions on the timeframe for settlement. They generally expire on a specific day each month, while swaps settle based on the average price over the course of the month. The swaps settlement process works better with the way most commercial and industrial consumers purchase fuel.

After all, there are hundreds of different grades and origins of crude oil. In the US alone, there are at least 35 different crudes[3], while globally it runs into hundreds[4], nearly all of which are not exchange traded. For them, it’s an OTC market.

Given the variety of grades and origins, accurately priced hedging requires a substantial volume of real-time data.  Among the various real-time OTC market data providers, TraditionData with its newly launched Oil Swap Model (OSM) can provide oil swaps pricing data directly from its 22 brokerage desks around the world. The OSM provides 13,000 updates a second across 20,000 instruments, which allows users to identify users to spot arbitrage opportunities within inter-product and inter-regional spreads.

The nature of these markets means that swaps are considered the most popular hedging instrument used by oil and gas producers, because hedging with swaps allows them to lock in or fix the price they receive for their oil and gas production. Swaps can be customised to suit the specific product – futures contracts cannot. They are available on nearly all types of fuel, including bunker fuel, diesel fuel, petrol, heating oil, jet fuel, etc. 

With the world in the middle of an energy crisis, the oil swaps markets have never been so crucial in helping countries and companies to manage their energy costs – and the role of high-quality data in helping them do that as effectively as possible has never been more vital either.

[1] CBOE Crude Oil Volatility Index




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