Crude Oil Contracts
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AONG manager 2017-04-30
Oil Contract
Major traded oils
More than 170 different oils are traded on the market, but this section will discuss the three
major oils that usually attract the most attention, both in the news and in the markets around
the world. West Texas Intermediate (WTI) is a crude oil of extremely high quality and
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because of this property, it is possible to extract more gasoline from a single barrel compared
with most other crude oils traded on the market. The WTI has an API 10 gravity of 39.6
degrees, which gives the oil the characteristic of “light”; moreover the concentration of 0.24
percent of sulfur makes it a “sweet” crude oil. Those qualities together with the extraction
location, make the WTI the prime crude oil refined within the United States, which is the
largest gasoline consuming country on the planet. The vast amount of the WTI crude oil is
refined mainly in the Gulf Coast and in the Midwest regions. Because of its characteristic, the
WTI crude oil, is usually priced higher than the other two main traded oil: respectively $5-7
per barrel higher than the OPEC basket and $1-2 more than the “Brent Blend”.
here is live WTI crude oil price:
Read also Crude Oil Price
Brent Blend
we always hear about Brent Crude Oil Price and Brent Blend in the news, so let us first
define Brent Blend:
is a combination of different types of crude oils, which are extracted from 15 fields throughout
the Nynas system, located in the North Sea, and the Scottish Brent. The “API Gravity” of this
particular oil is 38.3 degrees: this characteristic makes it a “light” oil similar to the WTI, but
not as much as the WTI. In the same way, the quantity of sulfur contained (0.37 percent),
makes it a “sweet” crude oil, but not as “sweet” as the WTI. Brent Blend properties make this
crude oil excellent for the production of gasoline and middle distillates, which are most used
in North-West Europe. As for the WTI, the production of the Brent is in a declining trend, but
remains one of the major benchmarks to analyze the price of crude oils both in Europe and
in Africa. Usually the Brent Crude Oil price is approximately $4/barrel higher than the OPEC
Basket price and $1-2 lower than the WTI.
here is live Brent Crude Oil Price:
OPEC Basket Oil price
This is a weighted average of prices for petroleum blends produced by OPEC countries. The
basket is composed of 11 different types of crude oils from Algeria, Saudi Arabia, Nigeria,
Venezuela, Ecuador, Iran, Iraq, Kuwait, Libya, Qatar, UAE and Angola. The acronym OPEC
means “Organization of Petroleum-Exporting Countries” which is an organization that was
created in 1960 to generate common policies for the production quotas and the sale prices
among its members. Compared with the WTI and the Brent Blend, the OPEC oil contains a
higher percentage of sulfur and therefore is not as “sweet” as these oils; moreover, the
OPEC oil is not naturally “light” as the WTI or Brent. Because of these two reasons, the
quantity of gasoline that is possible to extract from this oil is lower, thus the prices of OPEC
oil are normally lower than the WTI or Brent.
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Futures contracts
A futures contract is an agreement between two parties to buy or sell an asset at a certain
time in the future for a certain price. Different from forward contracts, futures are traded on
regulated exchange markets. In order to be traded on exchange, the contracts need to have
standardized characteristics. Furthermore, because this mechanism does not allow the two
parties to know each other, the exchange also provides a guarantee that the contract will be
honored, acting as a clearing house. As already mentioned in the previous section, the
largest exchange markets, on which the futures contracts are traded, are both the CME and
CBOT. On these two exchanges and throughout markets all around the world, a very wide
range of futures contracts with completely different underlying assets are traded. Examples
of commodities, beside the above mentioned crude oil, are sugar, coffee, lumber, aluminum,
gold, silver and copper. The financial asset category includes stocks, currencies, indices and
treasury bonds.
Specification of a future contract
The exchange, when creating new futures contracts, has to specify exactly the nature and
the details of the agreement between the parties. Determined characteristics have to be
examined, which include the grade (quality), the size of the contract (the amount of the asset
that will be delivered), the location where the delivery will take place, and the exact date on
which the delivery will be made. In some situations alternative options for the delivery
locations or for the grade of the asset are possible, and are indicated on the contract. As a
common rule, the party who is trading a shortposition (the party that agreed to sell the asset
in the future at a prearranged price) has the faculty to choose the alternative that he prefers.
When the party who has the short position is ready to deliver and thus has made a decision
among the alternatives, the party has to communicate its selection to the exchanges through
the issue of a notice. The main specifications defined by an exchange are:
The Asset
When a futures contract regards the commodities market this determination of the grade is
fundamental for the proceeding of the transaction: within the market there are a wide range
of different qualities of any commodities, thus it is important that the exchange determines
the minimum grade that is acceptable. As an example the New York Cotton Exchange has
stipulated the grade of its orange juice future contract as: “US Grade A, with Brix value of not
less than 57 degrees, having a Brix value to acid ratio of not less than 13 to 1 nor more than
19 to 1, with factors of color and flavor each scoring 37 points or higher and 19 for defects,
with a minimum score 94.
Another example by the random length lumber futures specified by the CME: “Each delivery
unit shall consist of nominal 2 x4s of random lengths from 8 feet to 20 feet, gradestamped
Construction and Standard, Standard and Better, or #1 and #2 however, in no case may the
quantity of Standard grade or #2 exceed 50%. Each delivery unit shall be manufactured in
California, Idaho, Montana, Nevada, Oregon, Washington, Wyoming, or Alberta or British
Columbia, Canada, and contain lumber-produced from grade-stamped Alpine fir, Englemann
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spruce, hem-fir, lodgepole pine, and/or spruce pine fir. For certain commodities there is also
the possibility to deliver a range of grades of the asset, but, in this case, the price paid from
the counterpart depends on the grades of the commodities chosen for the delivery. As an
example, in the CBOT, the standard grade of a corn futures contract is the “Number 2
Yellow”, but substitutions are allowed, therefore the price has to be adjusted respecting the
rules and procedures established by the exchange. Differently from the commodities, the
financial assets that underlie the futures contracts are usually well defined and do not leave
space for ambiguity. For example, it is not necessary to specify the grade of a currency.
Although the futures contracts on the financial assets may always seem clear, there are
some situations in which the determination of the prices become more complicated. In a
Treasury bond the underlying asset is any US Treasury bond that has a maturity date longer
than 15 years and that is not callable within 15 years. Because of the differing expiration of
the T-bond from the futures contract on the same Treasury Bond, the exchanges have
determined formulas that are utilized to adjust the price of the futures based on the coupon
and maturity date of the bond delivered.
The Contract Size
The contract size determines the amount of the underlying asset that has to be delivered for
a single contract. Finding the optimum amount for delivery is a key decision for each
exchange. If the stabilized contract size is too large, then the traders who wanted to hedge
small positions or make small speculation trades will not be able to operate on the exchange.
On the other hand, having a too small contract size, will increase the overall cost of
transaction, as the number of contracts that will be necessary to cover the same amount will
rise. There is no a correct size of a contract, but it depends always on the user who takes
part in the transaction. Whereas the values of some futures contracts are a few thousand
dollars for some agricultural products, others can be much higher, such as the crude oil or
more generally the financial futures that have a face values of over $100,000. In some
exchanges, other types of contracts have been introduced in order to attract small investors.
An example of those smaller contracts, called “mini”, is the E-Mini S&P500 Futures, which
has a contract one-fifth the size of the regular S&P500 Futures.
Read Also Crude Oil Trading
Delivery Arrangements
The exchange has to determine the location where the delivery will take place. This
specification is a factor of key importance for commodities that implicate significant
transportation costs. For example, the CME specifies the delivery location of random-length
lumber futures contracts as: “On track and shall either be unitized in double-door boxcars or,
at no additional cost to the buyer, each unit shall be individually paper-wrapped and loaded
on flatcars. Par delivery of hem-fir in California, Idaho, Montana, Nevada, Oregon, and
Washington, and in the province of British Columbia.” If there is the possibility of alternative
delivery locations, the price that the party selling the futures contracts receives will be
adjusted according to the location chosen. For example, the corn futures contracts that are
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traded within the CBOT gives the possibility to the party with a short position to deliver the
commodity in Chicago, Toledo, Burn Harbor or Saint Louis; although the commodity
delivered is the same, but because of the price adjustment, the deliveries that are made in
Toledo and Saint Louis will have a discount of $0.04 per bushel compared to the price traded
in Chicago.
Delivery Months
Futures contracts based on the same underlying asset have different delivery months. The
exchange has to determine the period (month) in which the operation of delivery can be
executed. As a general rule on the futures contracts, the delivery can be made during the
whole month. The delivery months are not fixed, but can vary on each contract. The delivery
period and modality of the Light Sweet Crude Oil Futures at the CME/NYMEX is defined as:
(A) Delivery shall take place no earlier than the first calendar day of the delivery month and
no later than the last calendar day of the delivery month.
(B) It is the short’s obligation to ensure that its crude oil receipts, including each specific
foreign crude oil stream, if applicable, are available to begin flowing ratably in Cushing,
Oklahoma by the first day of the delivery month, in accord with generally accepted pipeline
scheduling practices.
(C) Transfer of title-The seller shall give the buyer pipeline ticket, any other quantitative
certificates and all appropriate documents upon receipt of payment. The seller shall provide
preliminary confirmation of title transfer at the time of delivery by telex or other appropriate
form of documentation.
Although this chapter discusses about delivery methods and periods, most of the futures
contracts do not lead to actual physical delivery. The traders usually decide to close their
open positions before the expiration of the contract and thus before the delivery date. This
operation can be done by entering into a trade with the opposite direction in respect to the
original one. For example, a Chicago trader who sold a contract of crude oil on April 3, can
close out his position by buying a contract (i.e. a long trade) of the same asset on May 3. In
this case, the investor will register a profit or a loss depending of the difference of the futures
prices between April 3 and May 3.
Price Quotes
The futures contract prices are created in a way that is convenient to understand them. For
example, the crude oil futures price at the CME is quoted as two-decimal places of dollar per
barrel. Therefore the minimum movement that the price can have is $0.0117. The Natural
Gas futures contract listed at CME is still quoted in dollars, but given its different nature, it is
listed at dollar per mmBtu (British Thermal Units) and the minimum price variation is $0.0001
for MMBtu18 .
Price Limits and Position Limits
For the vast majority of futures contracts, the limits of the daily price movement are specified
by the exchange. If the price increases and hits the upper limit set by the regulations, the
contract is “limit up.” On the other side, if the price of the contract drops to the lower level, it
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is said to be “limit down.” Usually, when the price hits either the upper or the lower limit, the
transactions of the day for that futures contract ceases. In some particular cases, however,
the exchange can decide to change the limits and therefore not to end the trading day. The
main purpose of the price limit is to preclude large price movements, which may be
generated by the trading operations of speculators. On the other hand, the price limit can
become a barrier that can artificially contain the pace of the price movement of the futures
contracts, while the underlying asset may be moving (increasing or decreasing) its price at a
faster pace. An example of price limit regulation on the crude oil Futures at the CME: “Initial
Price Fluctuation Limits for All Contract Months. At the commencement of each trading day,
there shall be price fluctuation limits in effect for each contract month of this futures contract
of $10.00 per barrel above or below the previous day’s settlement price for such contract
month. If a market for any of the first three (3) contract months is bid or offered at the upper
or lower price fluctuation limit, as applicable, on Globex it will be considered a Triggering
Event which will halt trading for a five (5) minute period in all contract months of the CL
futures contract. Position limits regulate the maximum amount of contracts that a single
trader may hold. The main purpose of these limits is to avoid a single speculator excessively
influencing the market.
References:
1. Technical analysis trading strategy – Masaryk University Faculty of Economics and
Administration.
2. Oil Market Basics – Office of Oil and Gas, Energy Information Administration.
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