Greg Newman, CEO of London-based proprietary trading house Onyx Capital Group, caught up with S&P Global Platts head of news for EMEA, Andy Critchlow, and global head of generating fuels Simon Thorne to discuss what the future holds for the financialization of energy markets.
Prop trading houses have largely replaced the role previously held by banks as market makers on the Platts eWindow communication tool for assessing the tradable value of commodities. Greg Newman is one of the founding partners of Onyx Trading, which started operating in 2016 as an oil derivatives trade house. In this interview with Platts on August 5, Newman shared views on driving factors for oil price in the coming months and the role of different types of trader in the market.
Do you see an upside for oil this year?
We personally think it’s going to steadily improve towards the $50 [per barrel] range as there’s more and more confidence for people putting their money where their mouth is. Ultimately, traders need to make a bonus. They need to generate returns on a respective basis. They need to make a call one way or another. I think if you need to be bullish or bearish right now, you’re going to be heading towards the bullish direction.
We were getting particularly excited about the market about six weeks ago, when we recovered very strongly, particularly in the Dated Brent space, and we saw all the evidence that the physical diffs hugely recovered very, very quickly into positive territory.
The wider European market in crude, in particular, largely rebounded because of the fuel oil market and this whole IMO switch that I think has gone under the radar in terms of real impact. Refiners aren’t really producing residual fuel oil at the moment. A lot of the VGO [vacuum gas oil] and heavy crude, things that can be blended into the IMO fuel, are being sent to that blending pool and not sent out as residual fuel. So actually, as opposed to the residual fuel cracks being very weak, they’re very tight because no one is producing it. And that, in turn, has supported the medium-heavy grades, and the North Sea followed suit.
So we were getting quite excited about how the market could follow through, but I think it just kind of exhausted itself too quickly. You can see the evidence that the Chinese imported so much from the US and wherever else too quickly. These cargoes have been offered back into Europe, for instance. And it’s probably just a bit of a tapered kind of level on the bullish run. But on balance, I still think we get out of this range and we head north, just because we are ultimately in a constructive market.
My main reasoning for that is just the refinery margin – not the classic refinery margin, the new refinery margin with IMO shipping fuel, the idea being you’ve got so much optionality. You can either buy your crude [and] blend it to a decent product, [or] you can buy traditional crude being a traditional refiner. And actually, your waste products, fuel oil and naphtha are really at quite attractive levels on a crack basis, very high levels relative to what they’ve been in the last few years. So you’re not too concerned about what’s going to be left over when you’re running through your CDU [crude distillation unit].
I think you’re not making a hell of a lot of money refining, but you’re definitely making enough to be buying crudes from around the world and running fully, and I think that’s quite constructive. And then we just need to see the overhang clear out a bit more, and we could be well on the way.
How does increased liquidity from retail investors tie into the financialization of Platts’ eWindow?
The retail side in my mind is always going to be a good thing for markets because it is just going to increase liquidity. The oil market has always been this kind of status quo of “no one really knows what’s going on”, and not that much transparency, but that’s really not the case these days. I think it’s more and more transparent as we go on.
In the retail space, in particular, as those volumes come in, the same thing that happened with foreign exchange, where you have a lot of retail trading, will take place. Now you’ve got the tightest market in everything you could possibly want, even in trading. We’re hedging as a firm forward FX rates of dollar sterling. And we’ll do it 12 months out, and it’s like three basis points – tiny, tiny spreads and huge volume – because everyone around the world has access to it and is trading it. I think on balance, it’s a good thing for transparency.
However, it was a bit worrying how it was being managed. It’s not the problem that retail money is in oil, it’s the problem of how that’s been allocated. Holding the front month as long as they did was clearly foolish with the WTI contract [financial players caught out by physical delivery terms for WTI were seen as contributing to the contract plunging into negative territory on April 20] and that had its implications.
But also, I think the job of a retail broker, or an ETF provider, is to be reflective of crude as much as possible. And I think there’s a way to do that to make it clear. I think basketing contracts, things like that, but we don’t because there’s starting to be an appreciation now of localized events. So for instance, we all know now very clearly that Cushing crude is completely different to Gulf Coast crude, and that’s why you guys are coming out with the Gulf Coast Select [Platts AGS, a US waterborne crude assessment launched in June].
How does that tie into greater financialization from institutions?
On the financialization of the professional space, on balance it is very good, because when I first entered trading in 2013, it was about applying a very simple kind of forward-curve arbitrage type of trading. Buying in March, selling in June, and trading out the time spreads and just managing all the risk. That works to eliminate some inefficiencies that are there, and that was obviously a good thing because the banks, the trade houses and whoever else had the physical barrels that were pricing the contracts that were underlying, but there was no one in between. So it was too monopolized in a way because it was just the people with the physical barrels that could have influence on the pricing. There were too few participants involved, and therefore, inefficiencies were huge.
So from 2013 up until now, it’s been humming. I mean you can see it in the swap volumes, or OTC [overthe-counter] financial futures volumes, which just skyrocketed in the last eight years. And in my mind, that’s down to two things. One, the move from mostly bilateral trading to electronic trading on the exchange, and [secondly] a lot of people getting access to that along with the rise of financial trading because we do that all day long. If there’s any inefficiency in any of the markets in oil contracts we will be there to try and iron that out and the relative value opportunities, and it’s not just us doing that.
That creates a very orderly market in terms of price. I would say that on the forward curve it is interesting because people have different opinions about the actual pricing of swaps. It’s not about getting off a hedge, it’s not about getting the right price for a hedge, or a future position, it is about the actual pricing of the contract. In my mind, financialization has provided what I’ve been saying tenfold, because before it was just the guys with the physical barrels doing what they want to do, and no one in between to exploit the inefficiencies in a wider sense.
Where do prop traders fit in and make the market more efficient?
I started trading Dated Brent in 2015 and the eWindow barely had any volume, or if there was volume, it was hugely inefficient. I mean, how you extrapolated the CFDs [Contracts for Difference] relative to the DFL (Dated to Frontline) prices and all that, was all over the place. And that’s since come well into line and everything is very well-functioning and I don’t see how that’s not a good thing.
From a pricing perspective, it means that for Platts you’re looking at your eWindow and you’re looking at the physical bids and offers. But when you look at the paper trades, instead of your job being very hard because you have to interpret everything and use the previous day highs and lows, there is now more than enough volume to go on in the North Sea strip and whatever else. It makes your calculation pretty straightforward, and I think that’s a great thing. You just have certainty in price discovery.
We don’t hold the physical – our job is to explore inefficiencies and to trade in and out of that. And yes, if you want to take speculative risk, that’s fine. But our primary job is for efficient price discovery. And I think that’s been really good for the industry as a whole. It just means that there’s a much lower barrier to entry. And actually, what we’re seeing is a lot more interest and desire from trade houses and majors who traditionally, even if a refiner, or a producer, that has a very sophisticated physical tendering process, would leave the paper market to someone else.
Do you subscribe to the idea that a physical market has a more complex understanding that ultimately drives it than exchange traded funds?
What I think the ETFs do very well is provide volume and enough liquidity for the people who should know, like the prop traders, the market makers and the physical, to put everything in line. It dampens the impact of a one-off hedge, or anything like that. So I actually see it as the opposite. If these guys come in and trade ETFs, or someone comes in speculating, a physical guy or a market maker should absolutely love it, because it means they can get their hedge off in one tick. It is fantastic and means we’re going to make more money. More volume is always good because it will create an environment that is more reflective of the physical environment.
So with the success you and others have had are you anticipating more people coming in and providing that sort of liquidity, more prop traders?
About 10 years ago the prop trader’s function was taken by the banks and there were so many. And all of them moving out to purely financing roles and very little paper volumes that first needed to be filled. And I think now it’s got to the stage where it’s a bit like the banks, in that you have a hell of a lot of competition to be in this space, and that’s very healthy because the market benefits. But it does create a barrier to entry. There is always room for more competition, but it’s a much harder ask.
Will commodity markets remain a niche corner of the financial world, or will they go electronic?
For an algorithm, or electronic markets to really take hold, you need a market and a very good market on every single contract, and you need depth to those markets with volumes all the way down as you go higher and lower on the price. I’d say we are 10 years off that.
But a company like ours is very into branching out into ensuring that we’re doing the market making on the one side. We’re driving flows in the right way in all these different contracts and all these different areas, but then also really passionate about educating on the services side, on how to do things correctly.
We think there’s going to be more and more volume coming in that didn’t exist before from corporates, actually also from oil traders and retail as a financial contract. There’s no reason why retail can’t be in this space, it is just a lack of understanding. So if we work to bridge that gap, and we’re hugely passionate about being the ones who can do that, I think there’s so much in the future.
We’ve got a huge amount ahead of us, and it will outpace oil demand – even if oil demand tapers off, it’s irrelevant because people that do have physical volume aren’t hedging 100%. There’s a huge amount of speculative volume to get and I would love to think that it can become like FX. It’s a great time to be in the market, and I think it’s got an explosion ahead of it.