Brynne Kelly (@BrynneandRic) is an independent portfolio manager who trades oil, natural gas, and electricity. She has been active in energy trading for more than 20 years and has held positions at Koch, BP, Aquila, Sempra, Cargill, and several hedge funds. She spoke to The Fuse about Twitter, oil and gas prices, and the evolving nature of oil markets.
Could you explain why you’re active on Twitter and how it helps you in your energy trading?
The standard form of communication in many markets has been AOL or Yahoo Instant Messenger. I used AOL IM to talk with, and stay connected to, everyone I knew in the market. Using IM allowed me to talk all day to other traders, brokers without leaving my desk. You need to talk to a lot of other people to constantly assess what is going on in the markets. The great thing about being on the trading desk was that you could hear information and sense when something changes in the market. The communication on the trading desk and through IM plays a role in assessing your opinion on the market as well as being able to transact.
Twitter has become the new trading desk.
When I began managing private money on my own, I was still using IM, but I started using Twitter for news. Surprisingly, Twitter evolved into a place where I could get the same environment and comradery that I had on the trading desk. Twitter has allowed me to make contact with legitimate traders and find robust information in my feed that actually adds value to my trades. I’ve had legitimate discussions with traders on and offline that have helped me replace what I lost from the trading desk or communicating through IM. In other words, the trading community is sharing a lot of useful information through Twitter. I’ve learned more from Twitter than I ever really expected. I’ve exchanged information with a lot of knowledgeable sources and picked up a lot of followers from tweeting my assessments of the cash markets. The cash markets, I believe, tell the story about physical fundamentals. Twitter helps me make more informed trading decisions despite all the excess chatter.
You started energy trading in the 1990s. Aside from Twitter, how has the nature of oil trading changed over the past two decades?
The difference in all commodities, although crude oil started the soonest, is that they used to be dominated by bilateral contracts. There was obviously very little transparency. Traders were completely dependent on their voice brokers and you were reliant on phone calls for information. Because everything was bilateral, the players were very big since the barrier to entry was large. The hurdles to establish bilateral contracts and credit with each counterparty did not lend themselves to individual traders in the energy markets. Oil trading was more of a niche market that relied heavily on logistics, but with the advent of central clearing, the bilateral hurdles have been removed for the benchmark contracts, which has ushered in a new generation of participants. Now, many players who come into the market don’t understand the days of bilateral contracts and look at WTI (NYMEX West Texas Intermediate) and focus solely on that. Trading has lost its connection to its pure physical nature. Obviously, the physical trading world still exists, but more and more of the market is dominated by financial players like hedge funds that include WTI as an asset class in their portfolio. As a result, new correlations among WTI, for example, have emerged and grown. Connections to news headlines, currencies, equities, and a host of things like ‘tic’ data that once would never have mattered to oil prices are now critical. One example is the correlation at times with equities, which has seemed to be more of a 1:1 positive this past year.
Oil trading was more of a niche market that relied heavily on logistics, but with the advent of central clearing, the bilateral hurdles have been removed for the benchmark contracts, which has ushered in a new generation of participants.
In my opinion, Dodd-Frank [Wall Street Reform and Consumer Protection Act] has changed the markets on a whole new level. Markets were moving in the direction toward financialization [even before the Act was signed into law in 2010], but Dodd-Frank has made it so every trade has to be cleared on an exchange. It kicked the door open for all of these algorithms. As a result, many trades are based upon algorithms and not simple fundamentals. Algorithmic players can purchase data from government sites and exchanges and build expansive correlations into their trading. This backdrop makes applying your fundamental view to the market more dangerous. For instance, the market could be well oversupplied and you make a trade based upon that, but complex algorithms have prioritized other relationships which, if in place long enough, change the market’s interpretation of the fundamental story altogether. The more capital that makes its way into a market, the more it can move around based on non-fundamental news. Fundamentals win out over time, but you could be stopped out long before.
How is trading oil different than say gas or power?
Natural gas, to me, is much easier because it’s regional. It’s not yet a global market (although LNG exports are pushing it in that direction, slowly). With less global capital allocated to the U.S. gas markets, it tends to trade closer to fundamentals and other traditional market indicators than crude oil. But that doesn’t mean natural gas prices can’t get divorced from physical fundamentals. Recently, it went to $2.90, rallying with other markets. But there was little recognition of how full storage was. Injections were lower than normal, but that was simply because only so much can be put in the ground each month when storage is already so high. Plus, the $/mmbtu equivalent coal price is well below $2/mmbtu in some areas. So far this year, natural gas price rallies have been met with displacement from the power generation dispatch stack. In additional, renewables like wind and solar take grid priority in places, meaning if the units are generating, their output automatically hits the grid and displaces gas generation. This development has led to lower spikes in peak power prices, which in turn leads to lower tolerance by generators to ‘pay up’ for natural gas. In addition, with the uncertainty around coal plants going forward (due to the Clean Power Plan), those generators are keen to be dispatched so they will undercut gas generation. This dynamic in an oversupplied gas market has so far kept gas prices in check and not rallying as traditionally expected.
Where is the oil market headed?
I could make an argument in many different directions. On the one hand, a lot of traders are waiting for an inflection point where prices start trending upward, similar to what happened in the late 1990s when the market bottomed out at $10 and rose for the next eight years or so to $147. On the other hand, due to innovations that are lowering production costs and restructuring of budgets by oil producing countries, there could easily be profitable producer hedging at current or lower levels. I see the market being range-bound by these two sentiments between $40-$50 for some time. The ‘oversupplied’ story that plagued the past 12 months is now a well-known narrative. The market has become well-versed in storage levels compared to historical levels. I find that story old (or ‘last year’s’ news), and think the market would have to move lower on something different than just crude oil inventory levels. We can’t go back to $20 on last year’s story. Cash spreads in the U.S., which I follow religiously, have not moved, indicating fundamentals have held steady. It’s a 50-50 probability right now. All eyes are on the gasoline and distillate products and whether there will be a crisis in crack spreads that will pressure refiners.
The ‘oversupplied’ story that plagued the past 12 months is now a well-known narrative. We can’t go back to $20 on last year’s story.
Which is why I believe the direction of crude is 100 percent dependent on gasoline and distillate prices right now. Crack spreads have remained pretty robust [around $14] despite high diesel and gasoline stocks. That tells me that crude can’t break down unless the crack spreads break down. If you tell me where gasoline and distillates are heading, I’ll tell you where crude is heading. Let’s see if the fall refinery turnaround season sheds any light on this.