Do You Knead to Hedge the CMA Roll?

April 21, 2020
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The WTI Calendar Month Average (CMA) Roll has fallen sharply due to the WTI forward curve moving into a steep contango. For those clients with exposure, AEGIS would recommend hedging the front two-to-three months of the Roll starting in June.

Hedging the first few months of the CMA Roll would help mitigate some of the severity in the month-to-month movement of the current curve. It would also leave some upside optionality farther out the curve should the supply and demand balance improve near the end of 2020.

The CMA Roll is the price difference between the NYMEX Futures contract and the CMA Swap price for a specific month. The CMA Swap is calculated as two thirds the price of the first nearby futures month, plus one third the price of the second nearby futures month. Therefore, the CMA Swap curve is derived from the futures curve, and the CMA Roll curve is derived from the difference between the swaps and futures.

The first chart below shows this relationship. Please note that the NYMEX WTI CMA curve is the CMA Swap price. The NYMEX WTI CMA and NYMEX WTI Futures prices are on the left axis, while the CMA Roll prices, the difference between the two curves, correspond to the right axis.

An unprecedented CMA Roll value, in an unprecedented WTI price scenario.
Even the next few months are historically weak, but still have downside risk.
After six months, the CMA Roll returns to near its historical range.

For example, the May CMA Swap price would be calculated as two-thirds the price of the June futures contract price plus one-third of the price of the July futures contract. Thus, having May NYMEX WTI futures prices collapse to negative $-37.00/Bbl, like they did on April 20, would not impact the May swap price directly.

AEGIS clients, please note that not all counterparties trade the Roll.

The oil curve is usually not extremely upward sloping or extremely downward sloping, so the CMA Roll has been small. Historically, the CMA Roll has typically traded within a tight range of -$0.50 to +$0.50. AEGIS usually only recommends hedging the CMA Roll when it is above ~$0.75/Bbl. This would mark the highest sustained levels in recent history. When the forward curve becomes so backwardated (downward sloping) that Roll rises to near +$0.75/Bbl, the curve has usually relaxed, moving closer to flat. Even at +$0.75/Bbl, we would only recommend hedging approximately six-months into the future, where the forward curve usually has less slope and a small CMA Roll.

The recent values of the CMA Roll are extreme, never seen before. Some comparisons with recent curves shows how far the market has moved. Below are two additional charts from one month before the “-$37/Bbl day” and from January 1, 2020, at the peak of the U.S.-Iran tensions.

At the start of 2020, a backwardated WTI curve generated a positive CMA Roll throughout 2020. These levels are statistically high.
This level marked a value AEGIS recommends hedging, under normal circumstances.

At the start of the new year, the front of the NYMEX WTI CMA and Futures curves were near $60.00/Bbl. The difference between these two curves is the CMA contract captures price through the entire month, excluding weekends. The Futures contract only captures price up to three days prior to the twenty-fifth day of the month, excluding weekends, unless the twenty-fifth day falls on a weekend. If that is the case, then the contract expires four days prior to this date. This timing disparity is why there is a difference in price between the two forward curves.

The Argus WTI CMA Roll (Gray Bar) is, again, the difference between the Futures price (Light Blue Line) and the CMA Swap price (Dark Blue Line). The price of the CMA roll is positive when the market is backwardated. This is because the Futures price is higher than CMA swap price.

Looking back one month, all three curves changed dramatically. The CMA and Futures forward curves entered a contago after oil prices collapsed. This was due to a persistent oversupply in the global market, as well as the COVID-19 outbreak smothering global oil and refined products demand.

As the CMA Swap and Futures forward curves entered a contango, the WTI CMA Roll became negative. This was due to the Futures price becoming lower than the CMA Swap price. The May futures price fell below the May Swap price because the May Swap is calculated using two-thirds the price of the June futures contract and one-third the price of July futures contract. Hence, the movement in the front of the Futures curve was only partially felt in the Swap curve.

During March, COVID-19 demand losses were forcing an upward-sloping set of WTI curves, and the CMA Roll was falling.
Dec 2020 CMA Roll has not moved much, even with extreme weakness in the front of the WTI curves.

Finally, refer back to the first chart provided, from April 20. Despite May Futures falling as low as -$37.00/Bbl, the May Swap remained above $20.00/Bbl. This is, again, because the Swap price is calculated using two-thirds the price of the first nearby futures price and one-third the price of the second nearby futures month.

Despite the front of the CMA Roll curve blowing out to -$60/Bbl, the rest of the curve flattens out after three-to-four months. However, there is still a risk of weaker Roll prices in the near term. If you plan on hedging the CMA Roll, AEGIS recommends starting with June 2020 and going out to August or September 2020. You have until the end of May to put on a hedge for the June Roll.

Let us consider two market scenarios that could play out in the United States.

Bull Case

First, production comes off quicker-than-expected, demand returns, and the U.S. eases storage capacity constraints. In this situation, you would likely realize losses on your hedges if you locked in the current Roll. This is because, if the listed factors occur, the curve would backwardate. However, you would still be paying out a negative value, month-to-month, on the roll portion of your hedges. This is especially true if you lock in the roll for an extended period of time.

Bear Case

In the ever-more-likely scenario that the U.S. does reach storage and infrastructure capacity, you would likely only realize severely weak CMA Roll prices in the front few months of the Roll curve.
In this case, AEGIS would expect producers to quickly throttle back, or shut-in, production as NYMEX WTI prices stay low due to physical constraints. Given the current state of capital markets for upstream producers, if wells were to be shut-in, it may be difficult for supply to restart and meet, what is forecasted to be, recovering oil demand in late 2020 or early 2021. If this occurred, the forward curve would also become backwardated. Thus, hedging the Roll could work against you if you are locked in for an extended period.

Overall, in both a bullish and bearish storage event, we would not advise locking in the Roll for more than a few months as we see potential for this trade to move against you.

While the Roll will help mitigate some of the future contango in the curve, AEGIS cannot guarantee this will protect 1:1 against pricing in the field. Unfortunately, the severity of this black swan event has forced the market into a steep contango. This has effectively eclipsed the ability of the roll to mitigate the disconnect between futures and physical markets in the short term.

We continue to monitor oil, gas, NGLs, and regional markets for hedging opportunities. To learn more and see AEGIS opinion and recommendations, go to AEGIS View publications, or contact info@aegis-energy.com. Like what you see? Share this article with the button on the bottom right of your desktop. Market questions or comments? Contact us at view@aegis-energy.com

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NOTICE: The content of this report is provided for information purposes only and has been prepared to describe current trends in the commodities markets. This information does not constitute either investment or hedging advice and is intended only for AEGIS clients. If you are not the intended recipient of this report, then you may not disclose, print, copy or disseminate this information. Otherwise, if you have received this transmission in error, then please notify the sender and delete the report.

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