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Fundamental Analysis                   Future Market Analysis

1.     Introduction of Energy                   Derivative Market

2.     Composition of Energy                    Crack Spread

     Crude oil                                  Calendar Spread

3.     Varieties of Crude oil                   Crude oil-Natural Gas

4.     Measurement                              MCX-NYMEX Crude

5.     OPEC

6.     History of Crude oil Prices

7.     Indian Scenario

8.     Global Exchanges

9.     Price Drivers

     Natural Gas

1.     Introduction

2.     Measurement

3.     Demand

4.     Supply

5.     Indian Scenario

6.     Factors affecting the Market

7.     Leading Exchanges
     Global Scenario

1.     2007

2.     2008

3.     2009

                            Executive Summary

Commodities market is the biggest ―non-financial‖ market and plays a vital role in
the working of the economy. Commodities influence a significant part of one’s life
and economy as a whole. The continuous growth of the commodity market has been
because of the growing global economy and commodities, being treated as attractive
investment avenues in the times of inflation and falling equity markets.

Of all the commodities, Crude oil plays the most important role since it significantly
influences the prices of other commodities and the movement of the entire
commodity market.

This report begins with the Fundamental Analysis of Crude oil and Natural gas which
provides all the facts about both these commodities. This part of the report can
provide one with the basic insights of both Crude oil and Natural gas, including their
usage, price movements, history, their global needs, etc. It also includes the basic
factors which influence the price movement of these commodities and gives all the
required facts and figures with corresponding graphs.

The second part of the report deals with Future Market Analysis of Crude oil and
Natural gas, whereby different strategies are being used to understand the price
movements of both the commodities and thereby, concluding with some profitable
investment hypothesis.

Crude oil and its relation with different by-products have been studied and different
opportunities of investment have been established.

Before the statistical analysis of these commodities, a basic about the derivatives
market, including insights about the future market, option market, and swap market
has been provided.

This report would help one to gain knowledge about the fundamentals of crude oil
and natural gas and the analysis would help one to understand the price movements
and come up with profitable investing opportunities.

We live in an increasingly interdependent world. And central to this is the global

Energy system, something on which billions of people rely on daily, from both the
social and economic perspective. It is an increasingly complex system, where the
right decisions need to be made in a timely manner, as the relationships between the
major facets of the industry become ever more intertwined.

The New York Mercantile Exchange (NYMEX) is the world's largest physical
commodity futures exchange, located in New York City. Its two principal divisions are
the New York Mercantile Exchange and Commodity Exchange, Inc (COMEX) which
were once separate but are now merged. The New York Mercantile Exchange handles
billions of dollars worth of energy products, metals, and other commodities being
bought and sold on the trading floor and the overnight electronic trading computer
systems. The prices quoted for transactions on the exchange are the basis for prices
that people pay for various commodities throughout the world.

NYMEX Division

1.     Coal
2.     Crude oil
3.     Electricity
4.     Gasoline
5.     Heating oil
6.     Natural gas
7.     Palladium
8.     Platinum
9.     Propane
10.    Uranium
Composition of Energy

Oil, gas, hydroelectricity, nuclear power and coal are the five constituents of primary
energy. Oil and gas account for 62.2% of the total world primary energy
consumption. This figure is higher at 64.8% for developed nations like the US. In
India, coal is the principle source of energy accounting for over 55% of the total
primary energy consumption. The reasons for the growing importance of oil and gas
are to be found in their multiple, varied and cost-effective applications. Further,
other factors such as environmental problems (in the case of coal and nuclear
energy), difficulty in handling (coal), higher capital costs, and limitation to specific
geographic regions (hydroelectricity) have restricted growth in the use of other forms
of energy.

(1)   Crude Oil:

Crude or crude oil is a mixture of hydrocarbons that exists in a liquid phase in
natural underground reservoirs. It remains liquid at atmospheric pressure after
passing through surface separating facilities. It accounts for 37% of the energy
consumption. United States followed by China and Japan are the top most oil
consuming countries and India is among the top 10 consuming
countries.The most common distillations of Crude oil are fuels.

     Fuels include:

1.      Ethane and other short-chain alkanes

2.      Diesel fuel (petrodiesel)
3.      Fuel oils
4.      Gasoline (Petrol)
5.      Jet fuel
6.      Kerosene
7.      Liquefied petroleum gas (LPG)
     Other Derivatives:

1.      Alkenes, which can be manufactured into plastics or other compounds
2.      Lubricants
3.      Wax
4.      Bulk tar
5.      Asphalt
6.      Petroleum coke
7.      Paraffin wax
8.      Aromatic petrochemicals to be used as precursors in other chemical

Varieties of Crude oil: Two main factors that determine the market value
of a specific grade of crude oil are Density (measured in API Gravity) and Sulphur
content, respectively, determining how light and sweet the oil is.

1.      West Texas Intermediate: High quality oil explored and physically traded in
        U.S. NYMEX is the primary exchange facilitating futures trade in this light
        sweet crude oil.
2.      Brent Crude Oil: A grade from North Sea, UK, Brent is a pricing benchmark
        for Crude from Europe and Africa.
3.      Middle East Crude Oil: It is a grade with a large physical market in Gulf
        region. Most of the Indian refineries use crude benchmarked against Middle
        East Sour Crude Oil. TOCOM is a prominent future platform to trade this


        1 US Barrel= 42 US Gallon.

        1 US Barrel= 158.98 Litres.

        1 Tonne= 7.33 Barrel.
Note: The measurement of barrels per tonne varies from origin to origin.

OPEC’s History: The Organization of the Petroleum Exporting Countries
(OPEC) is a permanent, intergovernmental Organization, created at the Baghdad
Conference on September 10–14, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and
Venezuela. The five Founding Members were later joined by nine other Members:
Qatar (1961); Indonesia (1962) – suspended its membership from January 2009;
Socialist Peoples Libyan Arab Jamahiriya (1962); United Arab Emirates (1967);
Algeria (1969); Nigeria (1971); Ecuador (1973) – suspended its membership from
December 1992-October 2007; Angola (2007) and Gabon (1975–1994). OPEC had
its headquarters in Geneva, Switzerland, in the first five years of its existence. This
was moved to Vienna, Austria, on September 1, 1965.

OPEC's objective is to co-ordinate and unify petroleum policies among Member
Countries, in order to secure fair and stable prices for petroleum producers; an
efficient, economic and regular supply of petroleum to consuming nations; and a fair
return on capital to those investing in the industry.

Facts about OPEC: OPEC controls almost 40% of the World Crude oil and
accounts for almost 75% of the World’s proven oil reserves. Its exports represent
55% of the oil traded internationally. Proved oil reserves of the world stand at 1200
billion barrels in 2005 of which OPEC has 902 billion barrels.

OPEC has tied its production management activity to the goal of maintaining the
OPEC Basket price which is a simple average price of a "basket" of seven crude
oils. OPEC uses the price of this basket to monitor world oil market conditions. Of the
major benchmark crude oils West Texas Intermediate and Brent are lighter and
sweeter, and therefore more expensive, than the OPEC basket.
       Yearly Basket Price

1996   20.29

1997   18.68

1998   12.28

1999   17.48

2000   27.6

2001   23.12

2002   24.36

2003   28.1

2004   36.05

2005   50.64

2006   61.08

2007   69.08

2008   94.45

2009   44.43
NON-OPEC Countries
Non-OPEC countries (countries not members of OPEC - the Organization of
Petroleum Exporting Countries) produced 62% of the world's oil (total liquids) in
2003. Since 1970, non-OPEC production as a share of world total oil production
reached a high of 71% in 1985 and a low of 48% in 1973, with a 60% average.

World Production:

     Year            Production ( mbpd )

     1983                   58.01

     1984                   59.71

     1985                   59.12

     1986                   61.91

     1987                   62.28

     1988                   64.62

     1989                   65.92
    1990                 66.78

    1991                 66.85

    1992                 67.35

    1993                 67.55

    1994                 68.94

    1995                 70.42

    1996                 72.31

    1997                 74.6

    1998                 75.71

    1999                 74.31

    2000                 76.92

    2001                 77.11

    2002                 76.79

    2003                 79.54

    2004                 82.9

    2005                 84.15

    2006                 84.8

    2007                 85.9

    2008                 85.59

OPEC Production:

              2007               2008      Feb-09        Mar-09        Apr-09

           1000bbl/day     1000bbl/day   1000bbl/day   1000bbl/day   1000bbl/day
Algeria                      1360         1390              1261      1256           1279

Angola                       1660        1,871             1,646     1,669          1,715

Ecuador                       507          503               480          448         451

Iran                        3,855        3,892             3,680     3,660          3,750

Iraq                        2,089        2,338             2,312     2,337          2,333

Kuwait                      2,464        2,554             2,263     2,230          2,254

Libya                       1,710        1,715             1,559     1,546          1,559

Nigeria                     2,125        1,947             1,795     1,763          1,725

Qatar                         807          840               768          754         775

Saudi Arabia                8,654        9,113             7,915     7,893          7,913

UAE                         2,504        2,557             2,263     2,246          2,240

Venezuela                   2,392        2,346             2,129     2,123          2,150

Total                      30,126       31,066            28,070   27,924          28,145

                       Top Producing Countries 2007(mbpd)

                                                                   Saudi Arabia
             2.556            2.626              10.413            United States
          3.309                                                    Iran
          3.743                                                    Canada
               4.401                                               Norway
                          Top producing Countries 2008(mbpd)

                                                                         Saudi Arabia
                        2.8     2.7                                      Russia
                                                                         United States
                                                     9.9                 Norway

                        Top Exporting Countries 2008(mbpd)

                                                               Saudi Arabia
             1.883 1.863                    8.408              United Arab Emirates
       2.394                                 6.882
                2.416         2.584                            Algeria

A brief history of Crude oil prices:
Crude oil prices behave much as any other commodity with wide price swings in
times of shortage or oversupply. The crude oil price cycle may extend over several
years responding to changes in demand as well as OPEC and non-OPEC supply.

1.     From 1958 to 1970 prices were stable at about $3.00 per barrel, but in real
       terms the price of crude oil declined from above $17 to below $14 per barrel.

2.     OPEC was formed in 1960.

3.     In March 1971, the balance of power shifted. That month the Texas Railroad
       Commission set proration at 100 percent for the first time. This meant that
       Texas producers were no longer limited in the amount of oil that they could
       produce. More importantly, it meant that the power to control crude oil prices
       shifted from the United States (Texas, Oklahoma and Louisiana) to OPEC.
      That is, there was no more spare capacity and therefore no tool to put an
      upper limit on prices.

4.    Crises in Iran and Iraq: The Iranian revolution resulted in the loss of 2 to
      2.5 million barrels per day of oil production between November, 1978 and
      June, 1979. Iran, weakened by the revolution, was invaded by Iraq in
      September, 1980. By November the combined production of both countries
      was only a million barrels per day and 6.5 million barrels per day less than a
      year before. As a consequence worldwide crude oil production was 10 percent
      lower than in 1979.

5.    US Oil Price Controls: The US imposed price controls on domestically
      produced oil in an attempt to lessen the impact of the 1973-74 price
      increase. The obvious result of the price controls was that U.S. consumers of
      crude oil paid about 50 percent more for imports than domestic production
      and U.S producers received less than world market price. In effect, the
      domestic petroleum industry was subsidizing the U.S. consumer.

6.    OPEC's Failure to Control Crude Oil Prices: OPEC has seldom been
      effective at controlling prices. Higher prices also resulted in increased
      exploration and production outside of OPEC. From 1980 to 1986 non-OPEC
      production increased 10 million barrels per day. OPEC was faced with lower
      demand and higher supply from outside the organization.

7.    From 1982 to 1985, OPEC attempted to set production quotas low enough
      to stabilize prices. These attempts met with repeated failure as various
      members of OPEC produced beyond their quotas.

8.    The price of crude oil spiked in 1990 with the lower production and
      uncertainty associated with the Iraqi invasion of Kuwait and the ensuing
      Gulf War.

9.    The price cycle then turned up. The United States economy was strong
      and the Asian Pacific region was booming. From 1990 to 1997 world oil
      consumption increased 6.2 million barrels per day.

10.   The price increases came to a rapid end in 1997 and 1998 when the impact of
      the economic crisis in Asia was either ignored or severely underestimated by
      OPEC. In December, 1997 OPEC increased its quota by 2.5 million barrels
      per day (10 percent) to 27.5 MMBPD effective January 1, 1998.

11.   Prices began to recover in early 1999 and OPEC reduced production another
      1.719 million barrels in April.

12.   With growing US and world economies the price continued to rise throughout

13.   Russian production increases dominated non-OPEC production growth
      from 2000 forward and was responsible for most of the non-OPEC increase
      since the turn of the century.

14.   In 2001, a weakened US economy and increases in non-OPEC production
      put downward pressure on prices. In response OPEC once again entered into
      a series of reductions in member quotas cutting 3.5 million barrels by
      September 1, 2001.

15.   In the wake of the terrorist attack of September 11th, crude oil prices
      plummeted. Spot prices for the U.S. benchmark West Texas Intermediate
      were down 35 percent by the middle of November.

16.   OPEC reduced its quota by 1.5 million barrels per day and was joined by
      several non-OPEC producers including Russia who promised combined
      production cuts of an additional 462,500 barrels.

17.   By year end oversupply was not a problem. Problems in Venezuela led to a
      strike at PDVSA causing Venezuelan production to plummet. In the wake of
      the strike Venezuela was never able to restore capacity to its previous level
      and is still about 900,000 barrels per day below its peak capacity of 3.5
      million barrels per day.

18.   On March 19, 2003, just as some Venezuelan production was beginning to
      return, military action commenced in Iraq. Meanwhile, inventories
      remained low in the U.S. and other OECD countries. With an improving
      economy U.S. demand was increasing and Asian demand for crude oil was
      growing at a rapid pace.
19.    The loss of production capacity in Iraq and Venezuela combined with
       increased OPEC production to meet growing international demand led to the
       erosion of excess oil production capacity.

20.    Other major factors contributing to the current level of prices include a weak
       dollar and the continued rapid growth in Asian economies and their
       petroleum consumption. The 2005 hurricanes and U.S. refinery
       problems associated with the conversion from MTBE as an additive to ethanol
       have contributed to higher prices. One of the most important factors
       supporting a high price is the level of petroleum inventories in the U.S. and
       other consuming countries.

Indian Scenario: Oil accounts for 30% of the total energy consumption in
India. Total oil consumption in India is about 2.2 million barrel per day. India import
about 70% of its oil consumption and exports nothing. India faces large supply
deficit as domestic production is unlikely to keep pace with the increasing demand.
India has a refining capacity of 2.5million barrel per day.

Global Exchanges:

1.     NYMEX (New York Mercantile Exchange).

2.     MCX (Multi Commodity Exchange).

3.     TOCOM (The Tokyo Commodity Exchange).
4.     IPE (The International Petroleum Exchange of London).

Price Drivers:
Since it accounts for 37% of the world’s primary energy consumption, the price of
crude oil is highly volatile. High prices lead to inflation, which in turn increases input
costs and reduces demand. Thus, fluctuation in the crude oil prices has both direct
and indirect impact on the global economy.

Therefore, the prices of crude oil are tracked very closely by investors the world
over. Higher crude oil prices mean higher energy prices, which can cause a ripple
effect on virtually all business aspects that are dependent on energy (directly or

There are many factors that influence the global crude oil prices including technology
to increase production, storage of crude oil by richer nations (one major indicator
that is tracked closely is the US crude oil inventory data), changes in tax policy,
political issues etc. In the recent past, we have seen many factors influencing the
prices of global crude oil.
These are some of the important factors that influence crude oil prices globally:

a) World Production
A large part of the world's crude oil share is produced by OPEC (Organization of
Petroleum Exporting Countries) nations. Any decisions made by OPEC countries to
raise the prices or reduce production, immediately impacts the prices of crude oil in
the global commodity markets.
                             US Crude Oil production (1000 bbls/day)

    5200                                                               US Crude Oil production (1000
    5000                                                               bbls/day)
           2000 2001 2002 2003 2004 2005 2006 2007 2008

b) Natural causes
In the recent past, we have seen many events driving volatility in the crude oil
prices. Events like a hurricane hitting the oil producing areas in the US have driven
the crude oil prices in global markets.

c) Inventory
Oil producers and consumers build a storage capacity to store crude oil for
immediate future needs. They also build some inventories to speculate on the price
expectations and sale/arbitrage opportunities in case of any unexpected changes in
supply and demand equations. Any change in these inventory levels triggers
volatility in crude oil's prices which in turn creates ripples in the stock markets.
d) Demand
The demand of crude oil is rising sharply due to high growth and demand from the
emerging economies. On the supply side, the major sources of supplies are still the
same as they were in the last decade. This is another factor that is influencing the
prices of crude oil upwards.

Crude oil inventories have demonstrated a highly cyclical pattern in the recent past.
Usually, crude oil inventories increase in the summer months and decrease in the
winter months. This is because cold temperatures in the winter increase the use of
energy for heating in many cold countries. The demand for fuel goes above supply
and results in a need to tap inventories.
Likewise, during warm summer months, supply generally exceeds demand and
petroleum inventories build up. Hence, the crude oil prices drop. Crude inventory
levels provide a good signal of the price direction. India imports more than 80
percent of crude requirements from oil producing countries and therefore fluctuations
in oil prices are being tracked more closely in the domestic markets.
Prices of essential commodities like crude are also one of the prime drivers of
inflation in the global economy. As we get more globalised, domestic firms and
investors need to understand the world economy and financial markets well, in order
to respond to the new realities of India as an open economy better.

World Oil Demand:

      2007               2008               2009

      mbpd              mbpd                Mbpd

       85.9              85.59             84.03*

Non-OPEC Supply:

        2007                2008               2009

        mbpd                mbpd               mbpd

        50.5                50.32              50.54*

e) Currency Fluctuation:

The world’s major crude oil and refined product market is traded in US
Dollars. Therefore, any change in the exchange rate between a country’s currency
and the US Dollar will have an impact on the cost of purchasing crude oil or refined

f) Limits in Global Refining Capacity:

In order to try meeting the growing demand for refined products, refineries
around the world are now running at near full capacity. New refineries will
need to be built to continue to meet demand which will need significant
investment, which is also increasing due to more stringent environmental
standards globally. This increasing cost of production affects the price of oil
and its refined products.

World's Largest Refineries (Barrels/Day)

           Names                  Production ( bpd )

 Exxon Mobil                                    5,357,850

 Sinopec                                        4,210,917

 Royal Dutch Shell                              3,985,129

 British Petroleum                              3,231,887

 Conoco Phillips                                2,799,200

 PDVSA                                          2,642,600

 Petro China                                    2,607,407

 Valero Energy Corporation                      2,422,590
 Saudi Aramco                                    2,005,000

 Total                                           1,934,733

 Pemex                                           1,706,000

 National Iranian Oil Co.                        1,660,500

 Chevron                                         1,221,900

Source: Reuters

Indian Refineries:

1.       Jamnagar Refinery (Reliance Industries), 660,000 bbl/d (105,000 m³/d)
2.       Mangalore Refinery (MRPL), 190,000 bbl/d (30,000 m³/d)
3.       Manali Refinery (IOC), 185,000 bbl/d (29,400 m³/d)
4.       Kochi Refinery (Kochi Refineries Ltd), 172,000 bbl/d (27,300 m³/d)
5.       Gujarat Refinery (IOC), 170,000 bbl/d (27,000 m³/d)
6.       Visakhapatnam Refinery (HPCL), 150,000 bbl/d (24,000 m³/d)
7.       Mumbai Refinery Mahaul (BPCL), 135,000 bbl/d (21,500 m³/d)
8.       Haldia Refinery (IOC), 116,000 bbl/d (18,400 m³/d)
9.       Mumbai Refinery (HPCL), 107,000 bbl/d (17,000 m³/d)
10.      Numaligarh Refinery Limited Assam (NRL), 58,000 bbl/d (9,200 m³/d)
11.      Bongaigaon Refinery Assam (IOC), 48,000 bbl/d (7,600 m³/d)
12.      Guwahati Refinery Assam (IOC), 20,000 bbl/d (3,200 m³/d)
13.      Digboi Refinery, Assam (IOC), 13,000 bbl/d (2,100 m³/d)
14.      Tatipaka Refinery (ONGC), 1,600 bbl/d (250 m³/d)
15.      Essar Refinery (Essar), 10.5 MTPA
16.      Reliance Petroleum Ltd. (Second Refinery - Completed), Jamnagar,
         580,000 bbl/d (92,000 m³/d)

g) Market Speculation:
Crude oil and refined product are traded on the open market and are therefore
subject to market speculation, which impacts prices. In recent years, there has also
been new entrants and increased interest in the oil commodities market, mainly from
investment funds and hedge fund managers. It is widely believed that this has added
to the volatility of oil prices.

(2)   Natural Gas:

Natural gas is made up of just two elements - carbon and hydrogen. It is a colorless,
odorless, environment-friendly energy source. It is a highly flammable hydrocarbon
gas chiefly consisting of methane. Natural Gas is mainly used in industrial,
commercial, transportation and domestic sectors. The power and fertilizers are the
largest consumers of natural gas. The five major natural gas producing
countries are Russia, United States, Arab League, Canada and United
Kingdom. Russia, the United States and Canada generate 40% of the world’s total
natural gas supplies. Led by the United Kingdom, total natural gas production from
all European Union countries is 6.5%. Countries with large populations like China and
India account for 1.8% and 0.9% of annual global natural gas output, respectively.
And the five major natural gas consuming countries are Russia, United
States, European Union, Iran and Germany. Canada produces 730 billion cubic
meters more gas than it consumes, while Russia’s net natural gas output is plus 46.2
billion cubic meters. In contrast, the U.S. consumes 113.2 billion cubic meters more
gas than it produces. Major producing reserves are found in the Rocky Mountains,
Texas and Louisiana. In addition, significant natural gas comes from offshore
production in the Gulf of Mexico.

Uses of Natural Gas:
  1.          Electricity generation.

  2.          Alternative motor fuel.

  3.          Petrochemicals.

  4.          Public and Commercial.

  5.          Industrial.

  According to the federal government, natural gas costs less to use in 2008
  than any other home energy source.

ENERGY SOURCE                                     $ PER THERM**

Natural gas                                       $0.595

Electricity                                       $2.783

Propane                                           $1.376

No. 2 heating oil                                 $1.583

  Source: Twin Cities metro prices, April 2009


              1 million British Thermal Units= 25.2 SCM.

              1 SCM= 1 cubic meter.

  Natural Gas Demand: The demand for Natural Gas is mainly driven by
  the following factors:
1) Weather: Cold temperatures in the winter increase the demand for space
heating with natural gas in commercial and residential buildings. Alternatively, hot
temperatures in the summer increase the demand for space cooling with air
conditioning, which also increase the demand for natural gas at electrical utilities
because the utilities provide the electric power that fuels most residential air

Natural gas demand usually peaks during the coldest months of the year (December-
February) and is lowest during the "shoulder" months (May-June and September-
October). During the warmest summer months (July-August), demand increases

2) Economic Growth: The state of the economy can have a considerable effect
on the demand for natural gas in the short term. This is particularly true for
industrial and to a lesser extent the commercial customers. When the economy is
booming, output from the industrial sectors generally increases. On the other hand,
when the economy is experiencing a recession, output from industrial sectors drops.
These fluctuations in industrial output accompanying the economy affect the amount
of natural gas needed by these industrial users. For instance, during the
economic recession of 2001, U.S. natural gas consumption by the industrial
sector fell by 6 percent.

3) Fuel Competition: When natural gas prices are extremely high, electric
generators may switch from using natural gas to using cheaper coal or fuel oil. This
fuel switching then leads to a decrease for the demand of natural gas, which usually
tends to drop its price.

4) Storage: Natural gas storage levels have a significant impact on the commodity’s
price. When the storage levels are low, a signal is being sent to the market indicating
that there is a smaller supply cushion and prices will be rising. On the other hand,
when storage levels are high, this sends a signal to the market that there is greater
supply flexibility and prices will tend to drop.
Natural Gas Supply: The supply for Natural Gas is mainly driven by the
following factors:

1) Pipeline Capacity: The ability to transport natural gas from the well heads of
the producing regions to the consuming regions affects the availability of supply in
the marketplace.

2)Storage: As natural gas injections (positive) represent additional demand,
withdrawals (negative) represent an additional source of supply which can be
accessed quickly.

3) Gas Drilling Rates: The drilling rates and gas prices form a feedback loop.
When supply is low, demand and thus prices are high; this gives a market signal to
the producer to increase the number of rigs drilling for natural gas. The increased
supply will then lead to decrease the pricing.

4) Natural Phenomena: can have a significant impact on natural gas production
and thus supply. Hurricanes, for example, can have an impact on the offshore
production and exploitation of natural gas.

Thus, this interaction between demand and supply determines the natural gas prices.
It is also affected by the crude oil prices. The latent demand of gas is estimated
twice its supply.
Indian Scenario: The current import is nearly 22% of domestic consumption
which is likely to decrease in the near future. Though there has been a decline in the
gas availability but there have been large discoveries by various private sectors. The
supply of gas from the private sector is 27% which is expected to increase by 6.4%
in the near future.

Factors influencing the Market:

1.     OPEC output and supply.
2.     Dollar fluctuation.
3.     US natural gas inventory data.
4.     Weather conditions.
5.     Demand from the power and fertilizer sectors.

Leading Exchanges:

1.     New York Mercantile Exchange (NYMEX).
2.     Multi Commodity Exchange of India Ltd (MCX).

Current Global Scenario:

The importance of oil and gas sector is perhaps best explained in terms of the
economic effects that oil supply disruptions have. Oil price shocks accompanying
supply disruptions have hurt a number of economies and have been a major cause of
inflation and recession, as was the case in the 1970s. Oil shocks weaken the
economy through direct and indirect costs which further deteriorates the economy’s
GDP which in turn creates further unemployment. Thus, there is a strong linkage
between GDP and energy consumption. Even during 1980-1990s:
1.        Prices were too low.

2.        Investments were scaled down.

3.        Drastic cost cutting strategies were put in place.

4.        Research and Development costs were reduced.

But with the beginning of this century, there has been an economic growth and
upsurge oil demand. In addition to that there were Hurricane related supply
disruptions in US. OPEC spare capacity has played a critical role in ensuring that oil
markets remained well supplied. OPEC has increased its crude supply by 4 million
barrel/day since 2003, with another 1 million barrel/day increase coming from its
natural gas liquids (NGLs). In addition, the industry is investing heavily to expand

Thus, today, what is apparent is that oil supply and demand fundamentals are
healthy. There is, and has been, more than enough supply to meet demand, and oil
stocks in major consuming countries are at comfortable levels. This should point
away from the direction of current price levels. Yet it has not, a sign of a significant
disconnect. How has this come about? There are a number of factors. These

1.        A move by many financial institutions into index trading and both regulated
          and unregulated commodity exchanges,

2.        the sharp slide in the value of the US dollar,

3.        ongoing geopolitical developments, and

4.        refining tightness.

While OPEC itself has no influence over speculation and investor behaviour, it
continues to take action in other important areas where it can make a solid,
meaningful contribution, in the interests of market order and stability. The key
examples are our Member Countries’ upstream capacity development, and where
possible, downstream expansion at home and abroad to help ease some of the
severe bottlenecks in the refining sector that have emerged in a number of consumer
countries in recent years. We continue to hear a number of voices pushing ideas of
resource pessimism, a topic that interestingly has been around for almost the
entire history of the oil industry. This is fuelling speculation. Looking at the overall
picture, however, the world’s remaining resources of crude oil and natural gas liquids
are clearly sufficient to meet demand increases for the foreseeable future. New
discoveries, reserve growth in existing fields, and the continuous application of new
advanced technologies should also lead to the world expanding its conventional oil
resource base to levels well above the expectations of the past. On top of this, there
is also a vast amount of non-conventional oil to explore and develop.

Availability is not an issue.

Resources are plentiful, but the challenge, particularly for OPEC, stems from the
uncertainty over how much future production will be required to satisfy
demand for oil while making available sufficient levels of spare capacity.

Drivers of uncertainty include consuming countries’ policies, the rate of
future world economic growth, technological developments and non-OPEC

It is critical that the world community makes sure access to reliable, affordable,
economically viable, socially acceptable and environmentally-sound energy services.
2007: Global oil consumption rose by 1.1% to 85.2 million barrels per day in
2007. The difference between production and consumption (3.69 million barrels per
day) is accounted for global stockpile changes, use of non-petroleum additives and
substitute fuels, etc. China’s, the second largest consumer in the world, demand rose
4.1% to 7.855 million barrels per day. Whereas U.S.’s consumption fell by 0.1% to
0.698 million barrels per day. Even though consumption in US fell, it remained the
largest oil consuming country in 2007, consuming about one-fourth of the world’s
total oil consumption.

Despite the slow growth in demand throughout the year, oil prices rose from above
$50 in January to $100 by the end of the year. The reason for the increase in the
prices were

1.     The U.S. Federal Reserve cut interest rates to 4.75%.

2.     Tight market conditions
3.    OPEC decision to hold production quotas steady

4.    Rising consumption

5.    Modest growth in non-OPEC supply

6.    Fairly low surplus capacity and

7.    Continuing risks of supply disruptions in a number of major producing

It was a weak Dollar, strong global economy during 2007 wherein China grew by
almost 13%.

CRUDE OIL               ($/bbl)

July 14,2006                 77.03

Jan 18,2007                  50.48

Feb 21,2007                        60

June 29,2007                       70

July 31,2007                 78.21

Sept 11,2007                 78.23

Sept 13,2007                       80

Oct 12,2007                  83.69

Oct 16,2007                  87.61

Oct 18,2007                  89.49

Oct 25,2007                        90

Nov 2,2007                   95.93

Nov 21,2007                       100
Nov 23,2007                     98.18

Crude oil Prices on NYMEX on 31st december2007 was $ 95.98/bbl.

Natural gas         markets exhibited lesser price movement in 2007. Growth in

natural gas production, record high liquefied natural gas (LNG) imports, and storage
volumes that exceeded the 5-year (2002-2006) average throughout the year
brought reduced price volatility to the natural gas market in 2007. On a simple dollar
basis, the price differences between the yearly minimum and maximum during 2007
was $3.81 per million British thermal units (MMBtu), or $3.92 per thousand cubic
feet (Mcf), significantly lower than those observed in 2005 and 2006. The average
annual Henry Hub spot price at $6.97 per MMBtu ($7.18 per Mcf) was 3.5 percent
higher in 2007 than the 2006 average price of $6.73 per MMBtu ($6.93 per Mcf). In
2007, the residential natural gas price was 5.4 percent lower than the 2006 price of
$13.75 per Mcf, but remained above the 2005 average price of $12.70 per Mcf. The
commercial and industrial sectors experienced price decreases of 5.7 and 3.3
percent, respectively, while the electric power sector recorded a 2.6-percent price

 Natural Gas
 Consumption in 2007

                                              cu meters

 1                     United States          652,900,000,000

 2                     Russia                 610,000,000,000

 4                     Iran                   111,800,000,000

 5                     Japan                  100,300,000,000
 6                     Germany                97,440,000,000

 7                     Canada                 92,900,000,000

 8                     United Kingdom         91,100,000,000

 9                     Ukraine                84,900,000,000

 10                    Italy                  84,890,000,000

 11                    Saudi Arabia           75,900,000,000

 12                    China                  70,510,000,000


On 4thJanuary 2008, crude oil prices on NYMEX was $97.91/bbl. The prices
increased till 4th July 2008 whereby it reached $145.28/bbl. The increase in the
prices was because of the increasing US stockpiles. Global economy was
growing at a rate of 4.5% per year. With 14,000 more cars on the road each
day, China's oil demand grew enormously. The large economies were growing at a
greater pace and thus consuming more of their own products which in turn created
shortage in supply and thus, an increase in price.

By the beginning of September 2008, prices had fallen to $110. OPEC secretary
Abdalla El-Badri said that it intended to cut output by about 500,000 barrels a day,
which he saw as correcting a "huge oversupply" due to declining economies and a
stronger U.S. dollar. On September 10, the International Energy Agency (IEA)
lowered its 2009 demand forecast by 140,000 barrels to 87.6 million barrels a day.
As many countries throughout the world entered economic recession in the third
quarter of 2008, prices continued to slide. In November and December, global
demand growth fell, and U.S. demand fell 10% overall from early October to
early November 2008 (accompanying a significant drop in auto sales). In their
December meeting, OPEC planned to reduce their production by 2.2 million barrels
per day, though they admitted their resolution to reduce production in October had
only an 85% compliance rate.
Thus, prices fell from almost $150/bbl to $44.60/bbl on 31st December, 2008.

                US Crude Oil       US Imports of Crude    US imports of Crude oil from
    Year         production                 Oil                      OPEC

               (1000 bbls/day)       (1000 bbls/day)            (1000 bbls/day)

   2000             5822                   9071                      5203

   2001             5801                   9328                      5528

   2002             5746                   9140                      4605

   2003             5681                   9665                      5162

   2004             5419                  10088                      5701

   2005             5178                  10126                      5587

   2006             5102                  10118                      5517

   2007             5064                  10031                      5980

   2008             4955                   9756                      5958
    6000                                                                        US imports of Crude
    4000                                                                        oil from OPEC
    2000                                                                        US Imports of Crude
       0                                                                        Oil (1000 bbls/day)









oil proved reserves
2008                                                                        barrels

1                           Saudi Arabia                    266,800,000,000

2                           Canada                          178,600,000,000

3                           Iran                            138,400,000,000

4                           Iraq                            115,000,000,000

5                           Kuwait                          104,000,000,000
6                   United Arab Emirates 97,800,000,000

7                   Venezuela           87,040,000,000

8                   Russia              60,000,000,000

9                   Libya               41,460,000,000

10                  Nigeria             36,220,000,000

11                  Kazakhstan          30,000,000,000

12                  United States       20,970,000,000

13                  China               16,000,000,000

(million barrels/day)           2004     2005      2006   2007   2008

World Oil Demand              82.41        84     84.98   85.9   85.43

OECD Europe Oil
Demand                        15.52     15.67     15.68   15.3   15.19
                                     OECD Europe Oil
                                     World Oil Demand

  2004   2005
Particulars           2004       2005    2006       2007       2008

                              Annual             Annual     Annual

                              Average            Average    Average

Oil Supply1


  United States3, 4    8.70       8.32    8.33       8.46       8.50

  Other OECD          14.11      13.56   13.26      13.01      12.43

  Total OECD          22.81      21.88   21.59      21.46      20.92


  OPEC5               33.27      34.95   34.74      34.39      35.72

  Former U.S.S.R.     11.34      11.76   12.15      12.60      12.52

  Other Non-OECD      15.69      15.97   16.05      15.96      16.31

  Total Non-OECD      60.30      62.69   62.95      62.95      64.56

 Total World Supply   83.11      84.57   84.54     84.42       85.48

Petroleum (Oil)


  United States3      20.73      20.80   20.69      20.68      19.42

  Other OECD          28.70      29.02   28.87      28.44      27.91

  Total OECD          49.43      49.82   49.56      49.12      47.33

 China                6.44    6.70    7.24    7.57    7.95

 Former U.S.S.R.      4.04    4.16    4.20    4.20    4.34

 Other Non-OECD      22.49   23.33   23.98   25.01   25.82

 Total Non-OECD      32.97   34.18   35.42   36.77   38.11

Total World Demand   82.41   84.00   84.98   85.90   85.43
Natural Gas in 2008:


1.   Consumption in 2008 reached 23.2 trillion cubic feet (Tcf), a near-record
     level, second only to the volume consumed in 2000.

2.   Natural gas consumption increased slightly from 2007 levels, likely because of
     an increase in heating degree-days.


1.   Natural gas wellhead prices exhibited a counter-seasonal trend, hitting their
     peak in mid-year, following the same pattern as many other commodity

1.   In contrast to high price spikes in the aftermath of Hurricanes Katrina and
     Rita in 2005, natural gas prices showed little response to Hurricanes Gustav
     and Ike and continued to slide through the end of the year.


1.   Cumulative hurricane-related production shut-ins in the Federal offshore Gulf
     of Mexico and onshore and State waters of Louisiana exceeded 400 billion
     cubic feet (Bcf) from early September through the end of the year.

2.   Working gas in storage exceeded the 5-year (2003-2007) average in the
     latter half of 2008 despite hurricane-related production disruptions and low
     liquefied natural gas (LNG) imports.


3.   During 2008, at least 84 natural gas pipeline projects were completed in
     the Lower-48 States, adding close to 4,000 miles of natural gas pipeline and
     about 43.9 Bcf per day of new capacity to the US natural gas pipeline grid.


4.   Net natural gas imports from all sources were at their lowest level since

5.   LNG imports fell 54 percent from the 2007 level to 352 Bcf.

6.   Three new LNG terminals opened, including the first new onshore terminal
     in more than 25 years.

1.     World Oil demand is expected to fall, whereas non-OPEC supply is expected to
       increase by 0.3million barrels/day.

2.     Continuing slowdown in demand and increasing spare capacity.

3.     Increasing US stockpiles.

4.     Demand for OPEC crude is expected to average 28.7 million barrel/day,
       representing a drop of 2.1 million barrel/day from the previous year.

5.     Promising developments instead of weak fundamentals.

6.     Dollar fluctuation dominates the prices.

March, 2009:

1.     OPEC basket average price-$45.78/bbl.

2.     OPEC production- 27.9 million barrels/day.

3.     Global economic growth has been revised down by 0.6% to show a
       contraction of 0.8%.

World Demand in 2008 was 85.6million barrels/day. Non-OPEC supply was 54.7
million barrels/day. Difference= 30.8 million barrels/day.

World Demand in 2009 was 84.2million barrels/day. Non-OPEC supply was 55.4
million barrels/day. Difference= 28.7million barrels/day.
Summary of Crude Oil:

                       2007      2008      2009      IQ 09

                       mb/d      mb/d      mb/d      mb/d

(a) World Oil Demand      85.9     85.59     84.03      84.47

(b) Total supply
excluding OPEC           54.53     54.63     55.22      55.23

Difference (a-b)         31.37     30.96     28.81      29.24

OPEC crude oil
production               30.13     30.97                28.24

Balance                  -1.24      0.01                     -1
               Crude Oil Imports (Top 15 Countries)

                   (Thousand Barrels per Day)

Country             9-Mar       9-Feb YTD 2009        8-Mar   YTD 2008

CANADA               1,845       1,913      1,901     1,795      1,886

MEXICO               1,092       1,219      1,203     1,232      1,220

VENEZUELA             949          960      1,029       858        980

SAUDI ARABIA          944        1,099      1,128     1,535      1,541

NIGERIA               860          457       607      1,154      1,102

ANGOLA                644          671       612        384        433

IRAQ                  587          554       570        773        697

BRAZIL                334          365       365        188        175

COLOMBIA              254          225       235        135        174

RUSSIA                219          139       173        108         68

ALGERIA               215          142       242        247        269

ECUADOR               210          243       241        231        217

KUWAIT                181          251       218        199        232
GABON                           108   89   106   63   54

NORWAY                          103   33    61   23   14

         Consumption   Growth

  1997         62.28

  1998         60.95   -2.14%

  1999         61.38   0.72%

  2000         63.76   3.87%

  2001         60.93   -4.44%

  2002         63.03   3.46%

  2003         61.03   -3.18%

  2004         61.17   0.23%

  2005         60.30   -1.42%

  2006         59.41   -1.48%

  2007         63.14   6.28%

  2008         63.53   0.61%

  2009         62.15   -2.17%

  2010         62.31   0.26%
                          U.S. Total Natural Gas Consumption
           70                                                                          20%
           68                                                                          18%
 Billion 66                              Consumption
cubic feet
           64                                                                          14%
 per day
           62                                                                          12%
           60                                                                          10%
           58                         Annual Growth             6.3%                   8%
           56            3.9%
           54                       3.5%                                               4% Change
           52       0.7%                       0.2%                  0.6%       0.3%   2% from
           50                                                                          0% Prior
           48                                       -1.4% -1.5%                        -2%
              -2.1%                                                       -2.2%
           46                            -3.2%                                         -4%
           44                                                                          -6%
                  1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Short-Term Energy Outlook, June 2009

                       U.S. Working Natural Gas in Storage
                 (Percent Difference from Previous 5-Year Average)





          Jan 2007               Jan 2008         Jan 2009             Jan 2010

Short-Term Energy Outlook, June 2009
Economic growth Rate:

            World    OECD      USA        Japan Euro-zone    China       India

     2008      3.1       0.9      1.1       -0.6      0.9            9           6

     2009     -1.4      -3.8      -2.8      -6.4      -4.2       6.5             5

Attempts to mitigate the impacts of oil price increases include:

1.   Increasing the supply of petroleum
2.   Finding substitutes for petroleum
3.   Decreasing the demand for petroleum
4.   Attempting to reduce the impact of rising prices on petroleum consumers.
Derivatives: An Overview

Derivatives are financial contracts, or financial instruments, whose values are
derived from the value of something else (known as the underlying). The
underlying value on which a derivative is based can be an asset (e.g., commodities,
equities (stocks), residential mortgages, commercial real estate, loans, bonds), an
index (e.g., interest rates, exchange rates, stock market indices, consumer price
index ), weather conditions, or other items. Credit derivatives are based on loans,
bonds or other forms of credit.

The derivatives markets are the financial markets for derivatives. The market can be
divided into two:

1.     For exchange traded derivatives : These are derivatives products that are
       traded via specialized derivatives exchanges or other exchanges. A
       derivatives exchange acts as an intermediary to all related transactions, and
       takes Initial margin from both sides of the trade to act as a guarantee. The
       world's largest[3] derivatives exchanges (by number of transactions) are the
       Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which
       lists a wide range of European products such as interest rate & index
       products), and CME Group (made up of the 2007 merger of the Chicago
       Mercantile Exchange and the Chicago Board of Trade and the 2008 acquisition
       of the New York Mercantile Exchange)

2.     For over-the-counter derivatives: These are contracts that are traded (and
       privately negotiated) directly between two parties, without going through an
       exchange or other intermediary. Products such as swaps, forward rate
       agreements, and exotic options are almost always traded in this way. The
       OTC derivative market is the largest market for derivatives, and is largely
       unregulated with respect to disclosure of information between the parties,
       since the OTC market is made up of banks and other highly sophisticated
       parties, such as hedge funds.

     Common Derivatives Contract Types:
1.    Futures/Forward contracts are contracts to buy or sell an asset on or
      before a future date at a price specified today. A futures contract differs
      from a forward contract in that the futures contract is a standardized
      contract written by a clearing house that operates an exchange where the
      contract can be bought and sold, while a forward contract is a non-
      standardized contract written by the parties themselves.

2.    Options are contracts that give the owner the right, but not the obligation,
      to buy (in the case of a call option) or sell (in the case of a put option) an
      asset. The price at which the sale takes place is known as the strike price,
      and is specified at the time the parties enter into the option. The option
      contract also specifies a maturity date. In the case of a European option,
      the owner has the right to require the sale to take place on (but not before)
      the maturity date; in the case of an American option, the owner can require
      the sale to take place at any time up to the maturity date. If the owner of the
      contract exercises this right, the counterparty has the obligation to carry out
      the transaction.

3.    Swaps are contracts to exchange cash (flows) on or before a specified future
      date based on the underlying value of currencies/exchange rates,
      bonds/interest rates, commodities, stocks or other assets.

Some more complex examples of these derivatives are:

                                           CONTRACT TYPES

 UNDERLYING         Exchange-       Exchange-
                                                      OTC          OTC             OTC
                         traded        traded
                                                     swap        forward        option
                      futures         options
                                  Option on
                  DJIA Index
                                  DJIA Index
                                  future         Equity     Back-to-
 Equity Index     NASDAQ                                                   n/a
                                  Option on      swap       back
                                  Index future

                                  Option on                                Interest
                  Eurodollar      Eurodollar                               rate cap
                                                 Interest Forward
                  future          future                                   and floor
Money market                                     rate       rate
                  Euribor         Option on                                Swaption
                                                 swap       agreement
                  future          Euribor                                  Basis
                                  future                                   swap

                                  Option on                 Repurchase Bond
     Bonds        Bond future                    return
                                  Bond future               agreement      option

                  Single-stock Single-           Equity     Repurchase
 Single Stocks                                                             Warrant
                  future          share option swap         agreement

Uses of Derivatives:

1.   Hedging: Derivatives allow risk about the value of the underlying asset to
     be transferred from one party to another. Hedgers face risk associated with
     the price of an asset. They use futures or options markets to reduce or
     eliminate this risk. Hedging also occurs when an individual or institution buys
     an asset (like a commodity, a bond that has coupon payments, a stock that
     pays dividends, and so on) and sells it using a futures contract. The individual
       or institution has access to the asset for a specified amount of time, and then
       can sell it in the future at a specified price according to the futures contract.
       Of course, this allows the individual or institution the benefit of holding the
       asset while reducing the risk that the future selling price will deviate
       unexpectedly from the market's current assessment of the future value of the

2.     Speculation and Arbitrage: Derivatives can be used to acquire risk,
       rather than to insure or hedge against risk. Thus, some individuals and
       institutions will enter into a derivative contract to speculate on the value of
       the underlying asset, betting that the party seeking insurance will be wrong
       about the future value of the underlying asset. Speculators will want to be
       able to buy an asset in the future at a low price according to a derivative
       contract when the future market price is high, or to sell an asset in the future
       at a high price according to a derivative contract when the future market
       price is low. Individuals and institutions may also look for arbitrage
       opportunities, as when the current buying price of an asset falls below the
       price specified in a futures contract to sell the asset

Future Market Analysis:

Crack Spread: is a term used in the oil industry and futures trading for the
differential between the price of crude oil and petroleum products extracted from it -
that is, the profit margin that an oil refinery can expect to make by "cracking" crude
oil (breaking its long-chain hydrocarbons into useful shorter-chain petroleum

Different by-products of crude oil:
1.     Gasoline

2.     Kerosene

3.     Aviation oil

4.     Diesel

5.     Heating oil: No.2 fuel oil, after gasoline accounting almost 25% of the yield of
       a barrel of crude. It trades in units of 42000 gallons (1000 barrels).

Two main Crack Spreads are offered by the Exchange:

1.     Reformulated Gasoline Blendstock for Oxygen Blending (RBOB)/ Crude oil.

2.     Heating oil/ Crude oil

Factors affecting the Crack Spread:

1.     Relative proportion of various petroleum products produced by a refinery.

2.     Particular blend of crude oil feedstock processed by a refinery and the
       capabilities of a refinery.


In the futures market, the crack spread is a specific trade involving simultaneous
buying and selling of crude oil contracts and one or more derivative products,
typically gasoline and heating oil. Crack Spread is used by refiners to hedge the price
risk of their operations. Refiners’ profits are tied directly to the spread, or the
difference between the price of crude oil and the price of the refined product. While
speculators attempt to profit from a change in the oil/ gasoline or heating oil price
differentials. If a spread was too narrow to produce a refining profit, you could
assume product prices would have to rise to catch up to crude oil prices. Therefore,
you would favour heating oil and gasoline contracts over crude oil. On the other
hand, if there is a large spread between product and crude prices, you could assume
refiners would push production and selling of unleaded gasoline and heating oil to
take advantage of the profit. This increase in selling would tend to push product
prices lower. Therefore, you would favour the crude oil over heating oil and gasoline.

Two alternatives available to the refiners are:
1.     Buy crude oil futures and sell product futures and vice-versa.

2.     Buy crude oil call options and sell product put options and vice-versa.

Selling a crack means buying Crude oil futures and selling product’s
futures and vice-versa. If the price of refined product is more than the price
of crude oil, then Crack spread is positive and vice-versa.

Crack spread futures and options trade as one-to-one ratio of crude oil to the
product. Crack spread futures also trade as 5-3-2, 2-1-1, 3-2-1 ratios of crude oil
and its products.

In the recent years, use of crack spread has become more widespread because of
price fluctuations and changing weather conditions, e.g. typically heating oil prices
are higher during the winter seasons, reflecting strong demand and thus, its prices
increases and therefore, crack spread increases.

Because a refinery’s output varies according to the configuration of the plant, its
crude slate, and its need to serve the seasonal product demands of the market, the
NYMEX Division energy futures market can provide the flexibility to hedge various
ratios of crude and products. The Exchange facilitates crack spread trading by
treating each spread trade as a single transaction for the purpose of determining a
market participant’s margin requirement.

Each refining company must assess its particular position and develop a
crack spread futures market strategy compatible with its specific cash market

Three-two-one Crack Spread:

The Crack spread is quoted in Dollars per barrel and thus, the combined value of
gasoline and heating oil has to be calculated first. Typically, prices of gasoline and
heating oil are quoted in cents per gallons and thus, price must be converted into
dollars per barrel by multiplying 42/100(there are 42 gallons in a barrel).

Now, 3-2-1 represents ratio of 3 crude to 2 gasoline plus 1 heating oil.
Assume gasoline prices are 57.5cents per gallon, heating oil are for 54.5 cents per
gallon and crude oil for $18.5 per barrel.

Gasoline—57.5cents*42/100= $24.15/barrel*2 barrels = $48.3.

Heating oil--- 54.5 cents * 42/100= $22.89/ barrel.

Total= $71.19.

Crude oil-- $18.5*3 = $55.5/barrel.

Therefore, the crack spread margin is $15.69/barrel.

Once the hedge is in place, the refiner need not worry about movements in absolute

Future prices. He need only be concerned with how the combined value of products
moves in relation to the price of crude.

Thus, a refiner can fix margin through a simple 1:1 crack spread or a refiner with a
diversified slate can trade in 3:2:1 crack spread.


Suppose In January, April Crude is for $ 18 per barrel and May Heating oil is for $
20.69 per barrel. If the refiner sells the crack i.e. buys April Crude oil futures and
sells May Heating oil futures, then he locks $(20.69-18)=$2.69 per barrel.

In March, the refiner purchases crude oil at $19/bbl in the cash market for refining.
He also sells heating oil in the cash market for $20.79/bbl. Therefore, net gain in the
cash market=$ 1.79/bbl.

Now future market is the cash market, thus Crude oil futures are also selling at
$19/bbl ($ 1 more than for what he purchased) and May Heating oil futures are also
trading higher ($0.1/bbl higher).

Now to complete the spread transaction, the refiner buys back the crack spread by
first repurchasing heating oil futures. It will cost him $10/bbl or $0.1/bbl more than
what he sold it for. He will also sell crude oil futures which will earn him $1/bbl more
than what he spent on it. Therefore, net gain in the cash market=$ (1-0.1)/bbl =
Thus, if unhedged, his gain is limited to $1.79/bbl.

But if hedged, his gain= $1.79/bbl + $0.9/bbl= $2.69/bbl (as he locked initially).

Purchasing a Crack Spread:

It is the opposite of Crack spread hedge or selling the crack spread. It entails selling
crude oil and buying refined products.

When refiners are forced to shut down for repairs or seasonal turnarounds, they
have to enter the crude oil and products’ spot market in order to meet the demands
of existing customers. Unable to produce further refined product, they buy from the
spot market and since they face a storage problem, they sell crude in the spot
market. Thus, demand of refined products increases and supply of crude decreases.
Thus, there is a possibility of decrease in price of crude and increase in price of
refined products. Therefore, in order to protect themselves, refiners use a short
hedge against crude and a long hedge against refined products, i.e. they buy a crack

Analysis of Crack Spread:

Crack Spread is the difference in prices of refined product and prices of
crude oil. When it is said that an investor sells a crack spread, it means that
he/she purchases the crude oil futures and sells the heating oil futures. And
purchasing a crack spread means selling the crude oil futures and buying
the heating oil futures.

Crack Spread: Crude oil and Heating oil (NYMEX)

For the year 2006:

                                         Chart Title

                                                                        Crack Spread $/bbl
                                                                        Linear (Crack Spread $/bbl)
         0    50        100        150             200   250      300

During the entire year, crack spread remained in the interval of $(7.62-14.8)/bbl,
thereby, not providing enough scope to enter the market. The Crack Spread made a
high of $14.78/bbl and reached a minimum of $6.06/bbl, with an overall average of
$11.14/bbl. Correlation between the prices had been around 95%. Standard
Deviation of the crack spread was 1.87, thereby, creating an interval of $(9.27-
13.01)/bbl. Any deviations from this interval could have been used as a signal to

The scatter chart shows that the number of deviations from the mean had increased
when compared to the previous year but still the spread moved towards the average
everytime showing their weak sustainability at the extremes.

For the year 2007:
Interval calculated at the end of the previous year (2006): $(9.27-13.01)/bbl.

                                        Chart Title

                                                                     Crack Spread $/bbl
                                                                     Linear (Crack Spread $/bbl)
         0     50       100       150          200    250      300

The scatter graph shows that the crack spread remained near its average, thereby,
ensuring enough correlation between the crude and heating oil prices (99%).

In the year, the crack spread made a high of $18.48/bbl; a low of $8.38/bbl with an
average of $13.32/bbl. Standard Deviation of the crack spread was 2.27, thereby,
creating an interval of $(10.59-15.13)/bbl..

From the year 2008:

In the year 2008, the crack spread reached $15.5 (above the 2007 interval) on 8th
Feb 2008. On22nd Sept2008, Crack Spread was at its minimum of $6.89/bbl
basically due to 15.66% increase in crude prices and 5% increase in heating oil
prices. This increase was due to US government $700billion bailout plan and
decrease in dollar value.

From 1st Oct 2008, crude prices have always been declining.

The line graph below shows the movement of crude oil and heating oil prices
throughout the year.


                J J J J J F F F F M M M M A A A A M M M M Jun- Jun- Jun- Jun- Jul- Jul- Jul- Jul- Jul- A A A A S S S S Oct- Oct- Oct- Oct- Oct- N N N N D D D D
               an- an- an- an- an- eb- eb- eb- eb- ar- ar- ar- ar- pr- pr- pr- pr- ay- ay- ay- ay- 08 08 08 08 08 08 08 08 08 ug- ug- ug- ug- ep- ep- ep- ep- 08 08 08 08 08 ov- ov- ov- ov- ec- ec- ec- ec-
               08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08                                                 08 08 08 08 08 08 08 08                        08 08 08 08 08 08 08 08

From the above graph, it is pretty clear that both the prices moved in tandem. Thus,
the correlation between the prices was 99%.





         20.00                                                                                                                                                                         Series1
                                                                                                                                                                                       Linear (Series1)



                 0                         50                        100                        150                       200 y = 0.0005x + 20.187   250                       300
                                                                                                                                    R2 = 7E-05

The above line graph shows that the number of deviations of crack spread from its
mean had been less but the amount by which it deviated was large. In the year,
crack spread showed a maximum of $35.27/bbl; a minimum of $6.89/bbl and an
average of $20.24/bbl. Interval for further investment is calculated using the
Standard deviation of the crack spread of 4.48. Interval: $(14.96-23.92)/bbl

For the year 2009:
On 12th Jan 2009, the crack spread was $24.25/bbl, far above the calculated interval
of 2008. Thus, it could be used to enter the market by selling the crack spread, i.e.
purchasing the crude future and selling the heating oil futures.


                                                                                                                                                                                                                                                                                   Crude oil futures $/bbl
                                                                                                                                                                                                                                                                                   HO Prices $/bbl















































































The graph shows that the correlation between crude and heating oil prices
from 2nd Jan 2009 to 14th may 2009 is 38%. Thus, we see that the prices are
not moving in tandem. We see that initially the heating oil prices were far above the
crude oil prices but the spread had decreased enormously in the month of April-May.

               0                     10                         20                      30                          40                    50                         60                       70                         80                      90                    100



                                                                                                                                                                                                                                                                                 Linear (Series1)



The standard deviation calculated from 2nd Jan to 14th May is 6.3. Thus, the interval
is $(3.04-15.04)/bbl. Now, on 19th May 2009, the spread was $2.97/bbl (far below
the calculated interval ).
Why 38%?

Observing the data gives the information that till February, the percentage increase
in Crude oil prices have been lower than the percentage increase in the Heating oil
prices. Whereas the percentage decrease in price of Crude oil had been higher than
the percentage decrease in heating oil prices. This led to the increase in the Crack

From February onwards, the percentage increase in Crude oil had been more than
the percentage increase in heating oil prices. And percentage decrease in the Crude
oil prices had been lower than the percentage decrease in heating oil prices, thus,
leading to a decrease in Crack spread.

Till February,

1.     % increase in crude oil prices < % increase in heating oil prices

2.     % decrease in crude oil prices > % decrease in heating oil prices

3.     Thus, increase in Crack Spread.

February onwards,

1.     % increase in crude oil prices > % increase in heating oil prices

2.     % decrease in crude oil prices < % decrease in heating oil prices

3.     Thus, decrease in Crack Spread.

The reason for this lies in the Fundamentals of Crude and Heating oil:
1.       Heating Oil is the primary product of the distillate fuels, accounting for
         roughly 45 percent of the total distillate fuels. From the Short term Energy
         Outlook, May 2009 by EIA; it is clear that Distillates stock had increased
         from 2005 to 2009.

      The following table shows the figures:

                                                                     (Million barrels)

                2005           2006            2007          2008           2009

Jan             121.9          139.4           139.6         129.6          143.4

Feb             117.3          135.6           123.7         117            146.1

Mar             105.4          120.5           120           107.2          141.8

Apr             105.4          116.5           121.3         106.1          146.5

May             112.4          124             125.1         112.8          145.9

June            119.7          129.9           123.8         121.1

July            133.3          137.5           130.3         130.4

Aug             139.1          145.1           134.6         132.5

Sept            127.7          149.3           134.2         127.2

Oct             124.7          142.8           134.4         127.4

Nov             133.7          140.6           134.8         135.8

Dec             136            143.7           133.9         145.9
Since distillate stock is increasing, it is clear that even Heating oil inventories are
increasing, leading to fall in the price.

One of the major factors affecting the crude oil prices is US crude inventory. The
US crude stockpiles had increased from 311.6 million barrels as on 15 th May 2008 to
368.5 million barrels on 15th May 2009, i.e. there has been a % increase of 18.3%.
On the other hand, US Distillates stocks had increased from 109.1 million barrels on
15th May 2008 to 148.1 million barrels on 15th May 2009, i.e. an increase of 35%.
Therefore, decrease of heating oil prices has been far above the decrease in the
crude oil prices in 2009.

1.     Now we see that the Consumer Expenditure on Heating oil had decreased
       from 2007-08 to 2008-2009, giving a reason for the decrease in the prices of
       Heating oil and thereby, decrease in the Crack Spread.
2.      According to the above data, there has been a decline in the Consumption of
        Distillates fuels. Also, global highway diesel demand has been much stronger,
        causing much of the distillate yield to go towards Diesel. This ensures that, the
        consumption of heating oil had decreased over the time, leading to a decrease in
        the price and increasing the Crack Spread

                    Consumption (thousand barrels
                               per day)                      Annual Growth

                       2007    2008     2009    2010         2008     2009     2010

           Total      20,680 19,419 18,848 19,102          -1261.7 -570.6      253.5

        Gasoline       9,286   8,964    8,983   9,047       -321.3     18.6     63.6

        Jet Fuel       1,622   1,518    1,411   1,434       -104.5 -106.7       22.7

            Fuel       4,196   3,938    3,736   3,794       -257.7 -202.4       58.1

           Other       5,576   4,998    4,718   4,827       -578.3 -280.1      109.0

     Total %
     Change                                                  -6.1%   -2.9%     1.3%

     Source: EIA Short Term Energy Outlook, May 2009.

     For the year 2001-2009:
                                          Chart Title


                                                                           Crack Spread $/bbl
                                                                           Linear (Crack Spread $/bbl)


         0       500         1000         1500          2000        2500

Correlation: 97.8%.


If the crack spread is too wide, we can sell a crack i.e. buy crude oil futures and

sell heating oil futures. And if we see that the crack spread is too narrow, then we
can purchase a crack spread i.e. sell crude oil futures and sell heating oil futures.

But we must take into account the % positive and negative changes in the prices for
both the commodities.

Crude oil-Heating oil-Gasoline
 120.00                                                                                                                                                                                                                                                             Gasoline US$/bbl
 100.00                                                                                                                                                                                                                                                             Heating Oil US$/bbl
  80.00                                                                                                                                                                                                                                                             Crude oil US$/bbl
From 2005 to 2007, Heating oil and Gasoline prices followed a seasonal demand
trend. That is, Gasoline demand was high from March to July because of the Summer
Driving Season and Heating oil demand was high from August to January due to Cold
Weather. Gasoline use in the winter seasons was at always at seasonal low. The
peak period for gasoline consumption is between Memorial Day and Labor Day when
Americans use their cars to go on vacations.

However, during 2008, Gasoline prices were always lower than the
Heating oil prices.

In the year 2008, Heating oil was the fuel of choice for about 7 % of the 107 million
homes in the U.S., according to Energy Department. The figure was about 46% of all
homes in New England and 25% in The Middle Atlantic states.

The other big reason for Heating oil being more expensive than Gasoline was that
the world demand for Diesel oil was growing faster than for Gasoline. Diesel fuel is
essentially the same as heating oil, so the more diesel in use, the more that will be
reflected in the price of heating oil. While only about 3 percent of U.S. cars used
diesel fuel, that percentage was much higher in Europe and other parts of the world.
About 70 percent of the vehicles in France used Diesel Fuels.

Diesel was growing in popularity in many countries because engines that burn it
were as much as 30 percent more efficient than gasoline-powered ones, lowering the
overall cost of the fuel. All of that means that there was only one way heating oil
prices were likely to go over gasoline prices as Diesel fuel was used by more of the
World’s cars.
                                                        Chart Title

                                                                                       Crack Spread ( CR-HO )
                                                                                       Linear (Crack Spread ( CR-HO ))
       0         200          400           600                800           1000

                                                         Chart Title

 20                                                                                           Crack Spread ( CR-gasoline )

                                                                                              Linear (Crack Spread ( CR-
 10                                                                                           gasoline ))
  -5 0     100    200   300     400   500         600       700        800   900    1000


In both the above scatter charts (from 2005 to 2009), we can see that the deviation
from the mean, of Crack Spread between Crude and Gasoline was much more than
the Crack Spread between Crude and Heating oil. That is, the difference between the
Gasoline and Crude oil prices was highly volatile and didn’t sustain near its average.

We can also observe that the Crack Spread between Crude and Heating oil was never
negative, whereas for the gasoline, it went down to -$7.16/barrel. This means that
the Gasoline prices were even lower than the Crude prices at times.

           Avg Volatility Max Volatility
  Year          (%)           (%)

    2006              3.07           6.76

    2007              3.18           6.56

    2008              4.48          18.97

Heating Oil:

           Avg Volatility Max Volatility
  Year         (%)            (%)

    2005              3.56        11.02

    2006              2.84          5.81

    2007              2.67          6.11

    2008              3.96        13.53




1/4/2005                                                                         6/21/2006
1/4/2006                                                                         2/21/2007
5/4/2006                                                                         4/21/2007
9/4/2006                                                                         6/21/2007
1/4/2008                                                                         4/21/2008
5/4/2008                                                                         6/21/2008

9/4/2008                                                                         8/21/2008

       Heating oil
Thus, we can see that initially, the average volatility between the Heating oil prices
were much higher than that of the Gasoline prices. But lately, the volatility in the
Gasoline prices have been much higher than the Heating oil prices.

   NYMEX Crude-

                         Buy Crude-Sell                Buy Gasoline-Sell                   Total
 Moving Avg                  Gasoline         Profit          Crude          Profit        Profit

                               925            $/bbl            925           $/bbl         $/bbl

 5 days (1 SD)              233 times           32.5        206 times        -53.86         -21.36

 5 days (1.5 SD)             68 times         -15.07        52 times           -0.09        -15.16

 5 days (2 SD)               No Cases                       No Cases

 22 days (1.5 SD)           150 times        132.78         83 times           -17.8       114.98

 22 days (2 SD)              67 times          62.58        31 times           5.85         68.43

 22 days (2.5 SD)            19 times          21.98        13 times          11.39         33.37

 22 days (3 SD)               4 times          -1.88         6 times           5.67           3.79

 65 days (2 SD)              65 times          24.25        54 times                       -139.13

65 days (2.5 SD)   34 times     -40.73   26 times   -49.22   -89.95

65 days (3 SD)     16 times     -27.52   10 times    15.04   -12.48

132 days (2.5
SD)                43 times      9.91    13 times    24.33   34.24

132 days (3 SD)    22 times     -18.41   4 times     13.22    -5.19


5 Days moving
average                 none

22 days moving
average                1.5 SD

65 days moving
average                 none

132 days moving
average                2.5SD
Thus, we see that none of the cases worked out for 5 days moving average. Whereas
22 days moving average with 1.5 standard deviation benefited the most.

Since Gasoline is not yet traded in MCX, it is difficult to understand the trend.
But since the correlation between the Heating oil prices in both MCX and
NYMEX and that of Crude oil Prices in both the exchanges are quite high,
NYMEX gasoline price and its movement trend can be taken as a base to
develop and understand a trend in MCX.
Calendar Spread:

An options or futures spread established by simultaneously entering a long and short
position on the same underlying asset but with different delivery months. Sometimes
referred to as an interdelivery, intramarket, time or horizontal spread.


1.     We have used 9 days moving average, 22 days moving average, 65 days
       moving average and 132 days moving average with standard deviation of 1,
       1.5, 2, 2.5 and 3.

2.     The concept of ―STOP LOSSES‖ has not been used.

3.     It has been assumed that an investor enters the market when the spread is
       beyond the range and exits as soon as the spread is within the range.

 Moving Averages                      Buy Current-Sell Future                  Profit

 9 days (1 SD)                                 304 times                         70733.06

 9 days (1.5 SD)                               115 times                         40246.81

 9 days (2 SD)                                 27 times                          -8971.49

 9 days (2.5 SD)                               No Cases

 22 days (1SD)                                 273 times                       113524.19
22 days (1.5SD)           162 times            110820.08

22 days (2SD)              77 times             82424.42

22 days (2.5SD)            25 times              30767.9

22 days (3SD)              5 times                2590.4

65 days (1SD)             307 times            -21862.33

65 days (1.5SD)           172 times            119857.47

65 days (2SD)              76 times            103579.72

65 days (2.5SD)            37 times              73057.6

132 days (1.5SD)          177 times            -211552.6

132 days (2 SD)            93 times             99617.27

132 days (2.5SD)           32 times              89552.9

Moving Averages    Buy Future-Sell Current   Profit

9 days (1 SD)             232 times           -92040.8
9 days (1.5 SD)    96 times     -21251.7

9 days (2 SD)      22 times     -4734.01

9 days (2.5 SD)    No Cases

22 days (1SD)      262 times   -41111.81

22 days (1.5SD)    123 times    1994.89

22 days (2SD)      46 times     2845.93

22 days (2.5SD)     9 times     -1367.81

22 days (3SD)       4 times     -1373.92

65 days (1SD)      254 times   -58337.25

65 days (1.5SD)    122 times   10593.31

65 days (2SD)      48 times    25161.85

65 days (2.5SD)    20 times    20639.64

132 days (1.5SD)   87 times     4492.65

132 days (2 SD)    29 times     6222.64

132 days (2.5SD)    4 times     6480.24
Moving Averages    Profit (after brokerage)     No. of times of Profit

9 days (1 SD)                      -21307.72     42 (227 out of 536)

9 days (1.5 SD)                    18995.13       34 (81 out of 238)

9 days (2 SD)                        -13705.5      18 (9 out of 49)

9 days (2.5 SD)

22 days (1SD)                       72412.38     47 (252 out of 535)

22 days (1.5SD)                   112814.97      52 (149 out of 285)

22 days (2SD)                       85270.35     50 (61 out of 123)

22 days (2.5SD)                      29400.1      53 (18 out of 34)

22 days (3SD)                        1216.49        44 (4 out of 9)

65 days (1SD)                      -80199.58     51 (287 out of 561)

65 days (1.5SD)                   130450.78      58 (171 out of 294)

65 days (2SD)                      124518.22      62 (77 out of 124)

65 days (2.5SD)                     93697.24      67 (38 out of 57)

132 days (1.5SD)                  -207059.95      46(121 out of 264)

132 days (2 SD)                   105839.31       65 (79 out of 122)

132 days (2.5SD)                    96033.15      80 (29 out of 36)
Thus, from the above data, we can conclude that for all 9 days, 22 days, 65 days
moving averages, 1.5 standard deviation is the most effective and for 132 days
moving average, 2 Standard deviation is profitable.
Crude Oil and Natural Gas

For the year 2007:

Natural gas prices increased during the entire year due to the following factors:

1.     Total US natural gas consumption increased by 6.7% in 2007 to 23 trillion
       cubic feet compared to 21.7 Tcf in 2006.

2.     There was a continued construction of natural gas fired power plants in US.

3.     Residential natural gas consumption rose significantly in 2007, reaching 4.7
       Tcf, and increasing for the first time since 2003. Lower prices and weather
       that was colder than previous year boosted residential natural gas demand.

4.     Onshore production of natural gas in the United States reached 17.2 Tcf in
       2007, increasing 4.3 percent over the previous year. The increase in onshore
       production occurred as the number of rigs drilling natural gas prospects

5.     In 2007, at least 50 natural gas pipeline projects were completed in the Lower
       48 States, 4 more than were completed in 2006. These projects added close
       to 1,674 miles of pipeline and more than 14.9 Bcf per day of new capacity to
       the national natural gas pipeline grid, continuing the expansion cycle that
       started in 2005.

Crude Oil prices also spiked during the entire year due to the following factors:

1.     Increase in Global consumption of Crude oil to 85.2 million barrels per day.

2.     Enormous increase in Crude oil demand in China.
3.                   OPEC decision to hold supply.

4.                   Low surplus capacity.

5.                   Weakening dollar and a growing economy.

Natural gas price movement didn’t follow the Crude oil prices and thus, a
correlation of 65.6% existed. The average crude-natural gas ratio showed
an average of 9.08.

                                                                                                                                                                                                                                                                                                                                 Crude $/bbl
                                                                                                                                                                                                                                                                                                                                 Natural Gas $/bbl













For the Year 2008:

In 2008, seasonal weather was not as strong an influence in driving the natural gas
prices as it had been in the past. But weather did play a role in the natural gas
production and consumption in the Gulf of Mexico and Louisiana. Hurricane Gustav
and Ike hit the Gulf coast in September 2008 and the natural gas storage remained
below the 2007 level.

At 23.2 Tcf, consumption in 2008 was at a near-record level, second only to the 23.3
Tcf consumed in 2000. Total consumption in the United States increased by about
0.1 percent over the 2007 level. Overall, 2008 had 5.6 percent more heating degree-
days than 2007. Winter temperatures in 2008 were colder than their 2007
levels, although temperatures in 2008 were warmer than the 30-year average. The
near-record levels occurred in spite of downward pressures on consumption, such as
hurricane activity and a weakened economy. 2008 is the second consecutive year
consumption has increased after decreasing in 2005 and 2006.

Crude oil prices increased from $97.91/bbl to $145.28/bbl on 4th July 2008. This
increase was mainly due to increasing US stockpiles. Increasing demand with a
shortage in supply caused the prices to increase. However, in the later half, i.e. from
October onwards, the prices started declining due to economic downturn.

However, from the time crude oil prices started declining, even the natural gas prices
were decreasing.

Natural Gas prices followed the general pattern of crude oil prices as it gave
a spike during the summer season and decreased during the winter season.
But this pattern was contrast to the normal seasonal pattern of natural gas,
which usually increases during the winter season and decreases during the
summer season. Thus, the prices showed a correlation of almost 94%.
                                                                                                                                                                                                                                                                                                                                                                                                                         Crude $/bbl
                                                                                                                                                                                                                                                                                                                                                                                                                         Natural Gas $/bbl












The ratio of crude-natural gas prices showed an average of 11.41 for the
entire year.

For the year 2009:

Natural Gas prices have been decreasing during the entire period till May due to high
inventory. Whereas the crude oil prices have been increasing due to increasing
demand on account of positive sentiments of economic recovery. Thus, the
correlation between the prices till now, has been -6%, i.e. the price movements of
both the commodities have been in the opposite directions.




             40                                                                                                                                                                                                                                                                                                                                                                                                          Crude $/bbl
             30                                                                                                                                                                                                                                                                                                                                                                                                          Natural Gas $/bbl











Average ratio of crude to natural gas prices have been 11.5 to 12, but the
recent ratio is around 17.5 levels (17.64 on 26th may 2009). Number of
natural gas drilling rigs in US decreased from 1600 in number to 793. A fall in prices
coupled with the credit crisis halved drilling opportunities in the US. There has been
a fall in the output by the world’s largest producer Gazprom, by 12% to 12.4 billion
cubic meters/day. Thus, it is assumed that the prices of natural gas would rise to
touch the average.

Thus, it can be seen that crude oil and natural gas prices are not highly
correlated. Indeed in the recent times, the correlation has been very low
showing that there have been different factors affecting these prices in
different ways. Therefore, it would be wrong to say that if a factor affects
crude oil prices in an adverse way, it will also affect natural gas prices in the
same manner.

For the time being, however, oil is still cheap enough to remain the fuel of
choice for most of the world’s ever-growing fleets of cars, trucks, ships, and
airplanes. Oil will remain the top global energy source for the next few
decades, even with the ongoing development of natural gas, nuclear, and
renewable resources.

As per my analysis, I believe that the Heating oil prices would increase in the
short term, following its seasonal trend of increase in the winters. This
increase would further increase the Crack Spread between heating oil and
crude oil.

Also, crude oil is the core of the energy system and thereby, the economy
will always have some of its demand. Further, with the growth of the
developing economies like China and India, the consumption of crude oil is
surely to increase in the near future.



















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