Thursday, January 19, 2017

How Trump Crushed Millions Of Dollars In Oil Options Trades

President-elect suggests border-tax plan too complicated; WTI plummets against Brent for some contracts in 2018, 2019.

By Alex Longley
January 19, 2017

A corner of the oil market has been in a frenzy about potential tax-reform plans favored by House Republicans. Now, some who study the market say comments by President-elect Donald Trump have poured cold water on those plans, devaluing millions of dollars in options trades.

In recent weeks, traders increased bets that the U.S. crude oil benchmark price would rise above its global counterpart, amid Republican support for a so-called border tax affecting imports into the U.S. However, Trump described the tax plan as “too complicated” in an interview with the Wall Street Journal this week, casting doubt on the proposal and putting the bets on oil prices at risk.

“In the end, it appears that the market got wrong-footed by the recent comments of President-elect Trump,” Harry Tchilinguirian, head of commodity-markets strategy at BNP Paribas SA in London, said in an e-mail.

For much of this decade, West Texas Intermediate crude, or WTI, has traded at a discount to Brent, the main international grade, as U.S. supplies have surged due to a boom in shale-oil production. That discount also helped to prompt the nation in 2015 to lift its limits on crude exports, since relatively cheap, high quality American oil is attractive in the global market. A tax on oil imports would not only raise the price U.S. refiners pay for Brent, it would also trigger an increase in WTI by spurring more demand for the American grade.

The possibility of such a change in policy is having profound implications in the market for oil futures and options. Indeed, the market has been “fixated” on the border-tax issue, JPMorgan Chase & Co. senior oil analyst David Martin wrote in a report before Trump’s comments this week.

Narrowing Discount

Earlier this month, WTI gained sharply against Brent for some contracts in future years, amid speculation that a Republican president and a Republican-controlled Congress would agree on a tax proposal. For December 2019, WTI briefly traded at a premium to Brent. The discount for December 2018 WTI broadened $0.07 from Tuesday’s close, to $0.97 a barrel, at 10:59 a.m. in New York.

In addition, traders have bet roughly $61 million that the two grades would be at least at parity as early as next June, according to Bloomberg calculations from options trades. 

The value of those options diminished this week as WTI’s price plummeted against Brent, following publication of Trump’s remarks. Options contracts for WTI to trade at a $2 premium to Brent have halved in value since last week, while those betting on any kind of premium also declined.

“The reduced likelihood of an import tax appears to have had a strong impact on the middle- and back-end of the transatlantic futures spread,” analysts at Vienna-based consultancy JBC Energy GmbH said in a research note Wednesday.

To be sure, sweeping tax legislation is notoriously difficult to move through Congress, and Trump doesn’t take office until Friday. It remains to be seen what will happen when the president-elect and Republican leaders have a chance to work together on major policy changes.

“The WTI-Brent spread curve had undergone a dramatic shift due to the possibility of border tax adjustments,” Citigroup Inc. analysts including Seth Kleinman wrote in an e-mailed report Tuesday. However, “recent comments by President Elect Trump highlight differences between himself and House Republicans,” they said.

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