TRADERS SITG Part XXIV. The Commodity Capitalism "Too-Big to fail" return

Risk capacity is a co-function of the commodity firm financial surface and volatility level.

You would thought the contango structure would be giving commodity traders free money arbitrage. That is simply not the case. Simply put, there are different contango at different risk levels.

We opine that the 2 sigma Saudi Aramco’s induced events in the oil markets have been equally detrimental for traders naturally short in Value-at-Risk or the banks (longs) providing hedging to producers (shorts).

Explanations:

For example, when the 95% one-month Value-at-Risk is $12 per bbl, there is 95% confidence that over the next month the portfolio will not lose more than $12 bbl. This scenario happened on March 5th when Brent price plunged by more than 20%. The Value-at-Risk remains elevated since then.

What is impressive is that the VaR flat level normally reduces as prices take a nosedive, but this isn’t what happened.

[1]

Brent 95% 30-days VaR, or the daily market risk value of a position scaled for 30 days under 95% of confidence interval has soared to $24 a barrel.

Graph 1

via jacquessimon506.files.wordpress

One potential reason might be a skew, negative in the market.

Graph 2 shows a significant potential for price convexity. (READ there is considerable leveled risk even at these lower flat price range).

To illustrate how much risk level is imbricated in the energy commodities here is the computed 30-days commodity value-at-risk on a 2,000,000 Bbls VLCC.

From a risk perspective this VaR has gone from US$24M to US$48M while the nominal market value of a cargo has declined by $US31,20M”.

“The VaR has gone from US$24M to US$48M while the nominal market value of a cargo has gone down by $US31,20M”

Scale this up to a one million barrel a day trader, this becomes an unacceptable environment to trade in raroc terms.

VaR SCARCITY

The firms in aggregate (maybe with one or two exceptions) are already short in VaR and thus are adverse and limited in the capacity to give more Value-at-risk to their traders to harbor more risk.

The houses, short in VaR are squandered by the excessive levels of market risk.

Watch for renewed negative carry (incoming cash-flows that are smaller than their offsetting position obligations): some once again will face the too-big to fail moment in the game of the commodity capitalism. 

Banks/Financing should now be bracing for credit defaults.

They should re-approach ‘the setting of their risk tolerance’ that they have with these clients. 

Good move, in retrospect from BNP Paribas who chose to step-side Rue du Rhône last November.

 

[2]

whereas:

P0 is the Brent price as of today

P1 is the new price given VaR(T,α)

VaR(T,α)=−μΔt+σ√Δtzα where Δt=Tt

We want the implied 30-day VaR e.g ΔT = 30/250 @ α= 95%

 

Graph 2

VaR= P0-P1 [2]

East of P1 is equal to α, the agreed confidence level 95%.

 

Jacques S.

Special Advisor to the Merchants, Producers and Banks in the Commodity Trade Financing.

 

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