The all-time high net length for low sulfur gasoil futures swaps on ICE this week was not necessarily a sign of strength in the market, but a byproduct of the instruments used to short products that are typically hedged in conjunction with ICE LSGO, sources said.
The net length rose by 7,223 on the week to reach 358,379 contracts, the highest level on record, in the week to April 28, according to data released by ICE this week.
Sources said although the headline figure may sound bullish, in fact the length has risen as a result of the method used to short products that are priced off of ICE LSGO, including middle distillates differential swaps to ICE LSGO. Differential swaps – a spread between the physical product and the underlying ICE LSGO frontline swap – are widely used to hedge middle distillates products such as jet fuel, diesel and gasoil.
“The net length doesn’t surprise me. Every time you sell an east/west instrument or a product differential such as jet fuel for example, you end up long the futures swap,” a trader said. “People have been heavily shorting things, so everyone’s short the product and long the gasoil futures swap. It’s not bullish for the market.”
If a trader wants to enter a short position for jet fuel, this can be achieved by selling the CIF NWE jet cargo differential to the ICE LSGO frontline swaps – essentially a simultaneous sell and buy of the two legs. The result of the trade is a short position on the outright CIF NWE jet cargo and a long position in the ICE LSGO futures swap.
With many of the products that are priced of ICE LSGO being heavily shorted, this indicates that the broader market is actually weak, sources said.
A second trader said “so much prices off [ICE low sulfur] gasoil, so it’s very difficult to glean too much for that data, so I think that it’s not actually bullish. If you overlay prices, it looks chaotic, it doesn’t follow as it should so I would guess length is going up as a result of the products being shorted.”
The net length has risen during 2020 from a year low of 250,120 contracts on January 7.
The short positions rose 874 contracts in the week to reach 1,958, near the year to date low of 853 contracts seen on April 7, while long positions rose 11,872 to an all-time high of 360,337 contracts.
The ICE LSGO futures swap is a monthly cash settled future based on the ICE daily settlement price for low sulfur gasoil futures.
When asked about the effect of Covid-19 on the recent high in net length, Jeff Barbuto, global head of oil business development at ICE, said “at these price levels the fuel consumer side of this market finds it an attractive time to lock in their pricing.”
Barbuto said the implementation of the International Maritime Organisation’s legislation from January 1, 2020, lowering the sulfur content of ship emissions from bunker fuel at sea to 0.5% from 3.5%, had also contributed to increasing length in the contract.
He said that “following the introduction of IMO 2020 at the start of the year, physical hedgers, refiners and shipping companies have turned to ICE’s low sulphur gasoil first line to manage their price exposure to fluctuations in the price of bunker fuel.”
Shipowners had turned to ICE LSGO in 2019 to hedge their exposure to the move from 3.5% fuel to the cleaner 0.5% fuel as the regulation stipulated, sources said.
They said they were using a 0.5% marine fuel differential to LSGO in the physical market, until liquidity picks up in the 0.5% FOB Rotterdam assessment.
“It’s so much easier to trade against gasoil,” a trader said in Q4 2019. “That is where the market is going… as we have yet to see much liquidity on the 0.5% indexation.”
The increase in shorting of differential swaps to ICE LSGO can be seen by the collapse in prices and the increase in the number of offers seen in the S&P Global Platts Market on Close process.
Compared with January, April saw a much greater number of offers in the Platts MOC process, while having a similar number of bids, indicating the increase in selling of differential swaps to ICE LSGO.
April saw an average of 925,500/mt per day of middle distillate swaps offered in the Platts MOC process and 549,000/mt bid. January had a daily average of 557,000/mt offered and 499,000/mt bid.
The majority of traded volumes during April were in the May strip, with 320,000 mt, balance of month April on 190,000 mt and June on 70,000 mt.
The main buyers in the paper market in April were DV Trading with 135,000 mt traded, Trafigura with 135,000 mt and BP with 105,000 mt, while the main sellers were Shell with 250,000 mt, followed by Mercuria with 90,000 mt and Total with 85,000 mt.
Middle distillate swaps prices have fallen since the start of the year, moving inversely to the ICE LSGO futures swaps length, due to the demand destruction resulting from lockdown measure in place to tackle the coronavirus outbreak and the following oversupply as storage options filled up.