Aug 25, 2014

    Tap potential of energy futures

    WHILE geopolitical turmoil in the Middle East and Europe may have been responsible for surges in oil prices this year, the rallies have typically not been sustained.

    Over time, prices have a tendency not to break beyond their resistance barriers or dip below their support levels, said Avtar Sandu, senior commodities manager at Phillip Futures.

    The American benchmark for light sweet crude, the Western Texas Intermediate, has been trading in a range between US$89 (S$111) and US$105 a barrel, and the European benchmark, the Brent crude, between US$100 and US$115 a barrel, he noted.

    Though the areas from which oil is sourced include troubled regions - such as Iraq and Libya - the demand and supply remain balanced in the interim.

    "The areas where the Islamic State operates are not near the major oil wells, which are in Basra. Unless fighting spreads, we don't envisage major concern. What has happened so far has already been factored into the price," he said.

    While United States sanctions against Russia over the Ukraine crisis have targeted the country's oil industry, the implications will be seen only further down the road.

    "The oil companies need funding to find new sources of oil and they may face constraints in the future. Russia is the largest non-Opec (Organisation of the Petroleum Exporting Countries) supplier of oil," Mr Sandu said.

    However, Russia is also diversifying its customer base to include countries such as China and Japan, he noted.

    Earlier this month, oil prices dropped in response to news that Libya will be reopening its ports to export oil to Europe. "But there are still issues with the ports and fighting continues, so we don't see a lot of oil coming out of Libya," he said.

    On the whole, energy will likely be a sideways market for the next few months, with the exception of natural gas, Mr Sandu said.

    Demand for that commodity will hinge on the severity of winter in the US, which, despite the weatherman's best efforts, can be highly unpredictable.


    The resistance and support levels for energy commodities may offer traders a clear indication as to when to enter the market.

    Support is a level beyond which market movements will tend to stop and reverse. This is due to more people wanting to buy, but sellers being less willing to sell.

    Conversely, resistance is a level beyond which the market typically may not rise higher, as there are more sellers than buyers expected at those levels.

    Through derivatives like energy futures, a trader can buy when prices are at their support levels, and sell them during rallies. This is called going long.

    Alternatively, when prices are near resistance levels, he can go short and sell the futures contracts. This means that he will agree to sell at a certain price first, and hope to buy the commodity later at a cheaper price, hence making a profit.

    While the price movements in a sideways market may not be as great as in an extremely bullish or bearish one, the leveraged nature of futures means profits, as well as losses, are magnified.

    For example, with an initial margin of US$5,000, a trader can own a Brent crude futures contract with a value of over US$100,000. Despite the smaller margin, the gains and losses are calculated on the whole contract value.

    Thus, the key is to have a tested trading plan and know the risk-reward ratio of the trade you are making, advises Mr Sandu.

    It also pays to study the fundamentals of each commodity, such as the demand and supply, how weather conditions affect it, and the inventory levels, he said.