In this article, we will explore how Texan oil traders navigate volatility and what strategies they employ to manage risk.
The rise of U.S. crude exports has made Texas a key player in global oil prices, and the financial instruments used by traders to avoid or capitalize on price swings have become more central in limiting risks. Since the lifting of decades-old limits on crude exports in 2015, drilling technology has tapped vast fossil fuel reserves in U.S. shale regions, pushing exports to new heights. The Permian Basin, centered in Texas, has become the epicenter of this boom, with producers shuttling more output to international markets through a network of pipelines connected to ports in Houston and Corpus Christi.
As crude exports have surged, related derivatives have grown more central to limiting risks. Futures contracts, agreements for deliveries months or years in the future, are paramount to hedging strategies. Daily trading of WTI contracts tied to Houston and Midland has doubled from the same period a year earlier. A record number of those contracts remained unsettled as of Monday, representing attempts by producers, refiners, and traders to limit risk in the future.
Derivatives allow producers and traders to more precisely hedge before exports hit the water in the Gulf of Mexico. Those agreements are priced as differentials to WTI futures of blended crude delivered to a pipeline junction in Cushing, Okla., a more widely traded contract seen as the domestic benchmark price. In June, a Texas-produced crude will be added to the Brent complex, the global benchmark, making WTI the most important marginal pricing barrel on the globe.
The growth in crude tanker trips to Europe threatened to make a closely watched global benchmark less representative of real-world trading. For years, five types of crude produced between the U.K. and Norway have traded into the Brent complex, which Wall Street views as a bellwether for international prices. But the region’s production tapered in recent years, and the price-reporting agency Platts responded by considering new streams of crude to add to the basket to better represent physical trading and limit volatility. U.S. crude from Midland won out over oil from the Johan Sverdrup field off the Norwegian coast, largely because its light, sweet makeup more closely matched other crudes in the North Sea.
The shift towards the Gulf Coast has resulted in U.S. oil becoming the driving force of global oil prices. Chesapeake Energy Corp., one of the biggest stars of the fracking boom, has recently sent its shareholders $800 million in dividends, racking up $1.3 billion of profit in the first nine months of 2022. The company has bounced back from the pandemic and lockdowns, which caused revenue to dry up, and its stock has more than doubled since the company re-listed its shares in early 2021.
However, there are geopolitical risks that could disrupt the market. For instance, the Kremlin’s annexation of Crimea in 2014 led to Western sanctions that hit Russian energy companies and rattled global oil markets. The Biden administration’s focus on clean energy could also impact oil traders and producers, as the U.S. moves towards a low-carbon economy.
Overall, the boom-bust investing that has characterized the fossil fuel industry is likely to continue, as the industry is subject to unpredictable fluctuations in demand and supply. Nonetheless, the financial instruments used by oil traders have become increasingly sophisticated and central to managing risk in the face of market volatility.