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By Kasper Walet, Founder and Partner AI Energizer and Maycroft
I recently read a very interesting article in the Financial Times about how commodity trading firms are still lagging behind other trading sectors in using Artificial Intelligence solutions. but that the industry is trying hard to catch up. These findings are in line with my practical experiences in our advisory services business: AI Energizer.
Particularly in today’s market situation where margins are squeezed, commodity traders are looking for tools that could help them to increase profitability. Intelligent technologies such as robotic process automation and machine learning, offer new opportunities to improve process performance and realize significant cost savings. These technologies can be implemented in short sprints, focused on a specific problem, with manageable costs.
If you click here, you can read our white paper about successful AI projects we executed for two of the leading energy commodity trading firms in Europe.
Compared to other financial and industrial sectors, commodity traders are coming from way behind. Currency, equities and interest-rates investors have already used algorithms, machine learning and artificial intelligence to turn data into successful trades for years. Now, commodity traders are seeking ways of exploiting their information to help them profit from price swings as well. It really is a combination of knowing what to look for and using the right mathematical tools for it.
Traders are looking to gather data on a large scale and run machine-learning algorithms to find patterns linking fundamentals with price movements, thus improve decision-making in trading and, as a result, the profitability. With a properly trained algorithm and a sufficiently sized historical data set, a company using machine learning to identify patterns in the trading data - even when the data has inconsistencies – will reduce redundant trades and streamline the entire process. To accommodate all this commodity trading firms are investing in people, processes and systems to centralize their data.
Despite this new enthusiasm, the road to electronification may not come easily. One issue is that some of the larger commodities traders face internal resistance in centralizing information on one platform. With each desk in a trading house in charge of its profit-and-loss account, data are closely guarded even from colleagues. The move to ‘share all our data with each other’ is a very, very big cultural shift.
Another problem is that in some trading houses, staff operate on multiple technology platforms, with different units using separate systems. Rather than focusing on analytics, some data scientists and engineers are having to focus on harmonizing the platforms before bringing on the data from different parts of the company. Even where the digital infrastructure is in place, it may take some time before AI becomes a large part of commodities trading.
Company leaders should start with the following three steps:
Step 1: Focus on value
As AI can solve targeted problems, it's up to company leaders to identify applications that offer the most potential value. Demonstrating strong returns in a short time will convert the cynics. AI projects typically happen in a series of sprints and can be completed in around 3-4 months.
Step 2: Change Management
Automation alone does not save money or improve performance: People and processes will also have to change. This is an area where there is understandable anxiety; automation stokes fears that machines will take people's jobs. But practice suggests that many of the tasks being automated are activities people tend not to want to undertake, such as spending half the day pulling and loading data. Or they are tasks for which small automation can actually improve people's performance - for instance, by introducing predictive algorithms that help them make better decisions and free up their time for more rewarding, interesting, and higher value-add activities.
This is an entirely new way of working, and company leaders will need to ensure that both they and their people have the right knowledge and skills, such as programming and data science knowledge and process improvement skills - to be successful. And they'll need to ensure that everyone's mind-set and behaviors also shift accordingly.
Step 3: Strategy is King
The backbone of this new way of working is strategy. Companies need to know their own strengths. There will be "keep the lights on" activities that can become touchless, as well as differentiating activities that should become increasingly intelligent. Moreover, companies need to take a fresh look at their organizational structure to ensure that it gives teams the freedom to develop creative solutions and experiment.
Conclusion
Concluding we can say that digitization is increasingly driving trading, and needs to be embraced, as many commodities executives believe. “It’s another tool that traders have to understand.”
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Source: U.S. Energy Information Administration, Short-Term Energy Outlook (STEO)
In its January 2020 Short-Term Energy Outlook (STEO), the U.S. Energy Information Administration (EIA) forecasts that annual U.S. crude oil production will average 11.1 million b/d in 2021, down 0.2 million b/d from 2020 as result of a decline in drilling activity related to low oil prices. A production decline in 2021 would mark the second consecutive year of production declines. Responses to the COVID-19 pandemic led to supply and demand disruptions. EIA expects crude oil production to increase in 2022 by 0.4 million b/d because of increased drilling as prices remain at or near $50 per barrel (b).
The United States set annual natural gas production records in 2018 and 2019, largely because of increased drilling in shale and tight oil formations. The increase in production led to higher volumes of natural gas in storage and a decrease in natural gas prices. In 2020, marketed natural gas production fell by 2% from 2019 levels amid responses to COVID-19. EIA estimates that annual U.S. marketed natural gas production will decline another 2% to average 95.9 billion cubic feet per day (Bcf/d) in 2021. The fall in production will reverse in 2022, when EIA estimates that natural gas production will rise by 2% to 97.6 Bcf/d.
Source: U.S. Energy Information Administration, Short-Term Energy Outlook (STEO)
EIA’s forecast for crude oil production is separated into three regions: the Lower 48 states excluding the Federal Gulf of Mexico (GOM) (81% of 2019 crude oil production), the GOM (15%), and Alaska (4%). EIA expects crude oil production in the U.S. Lower 48 states to decline through the first quarter of 2021 and then increase through the rest of the forecast period. As more new wells come online later in 2021, new well production will exceed the decline in legacy wells, driving the increase in overall crude oil production after the first quarter of 2021.
Associated natural gas production from oil-directed wells in the Permian Basin will fall because of lower West Texas Intermediate crude oil prices and reduced drilling activity in the first quarter of 2021. Natural gas production from dry regions such as Appalachia depends on the Henry Hub price. EIA forecasts the Henry Hub price will increase from $2.00 per million British thermal units (MMBtu) in 2020 to $3.01/MMBtu in 2021 and to $3.27/MMBtu in 2022, which will likely prompt an increase in Appalachia's natural gas production. However, natural gas production in Appalachia may be limited by pipeline constraints in 2021 if the Mountain Valley Pipeline (MVP) is delayed. The MVP is scheduled to enter service in late 2021, delivering natural gas from producing regions in northwestern West Virginia to southern Virginia. Natural gas takeaway capacity in the region is quickly filling up since the Atlantic Coast Pipeline was canceled in mid-2020.
Just when it seems that the drama of early December, when the nations of the OPEC+ club squabbled over how to implement and ease their collective supply quotas in 2021, would be repeated, a concession came from the most unlikely quarter of all. Saudi Arabia. OPEC’s swing producer and, especially in recent times, vocal judge, announced that it would voluntarily slash 1 million barrels per day of supply. The move took the oil markets by surprise, sending crude prices soaring but was also very unusual in that it was not even necessary at all.
After a day’s extension to the negotiations, the OPEC+ club had actually already agreed on the path forward for their supply deal through the remainder of Q1 2021. The nations of OPEC+ agreed to ease their overall supply quotas by 75,000 b/d in February and 120,000 b/d in March, bringing the total easing over three months to 695,000 b/d after the UAE spearheaded a revised increase of 500,000 b/d for January. The increases are actually very narrow ones; there were no adjustments for quotas for all OPEC+ members with the exception of Russia and Kazakshtan, who will be able to pump 195,000 additional barrels per day between them. That the increases for February and March were not higher or wider is a reflection of reality: despite Covid-19 vaccinations being rolled out globally, a new and more infectious variant of the coronavirus has started spreading across the world. In fact, there may even be at least of these mutations currently spreading, throwing into question the efficacy of vaccines and triggering new lockdowns. The original schedule of the April 2020 supply deal would have seen OPEC+ adding 2 million b/d of production from January 2021 onwards; the new tranches are far more measured and cognisant of the challenging market.
Then Saudi Arabia decides to shock the market by declaring that the Kingdom would slash an additional million barrels of crude supply above its current quota over February and March post-OPEC+ announcement. Which means that while countries such as Russia, the UAE and Nigeria are working to incrementally increase output, Saudi Arabia is actually subsidising those planned increases by making a massive additional voluntary cut. For a member that threw its weight around last year by unleashing taps to trigger a crude price war with Russia and has been emphasising the need for strict compliant by all members before allowing any collective increases to take place, this is uncharacteristic. Saudi Arabia may be OPEC’s swing producer, but it is certainly not that benevolent. Not least because it is expected to record a massive US$79 billion budget deficit for 2020 as low crude prices eat into the Kingdom’s finances.
So, why is Saudi Arabia doing this?
The last time the Saudis did this was in July 2020, when the severity of the Covid-19 pandemic was at devastating levels and crude prices needed some additional propping up. It succeeded. In January 2021, however, global crude prices are already at the US$50/b level and the market had already cheered the resolution of OPEC+’s positions for the next two months. There was no real urgent need to make voluntary cuts, especially since no other OPEC member would suit especially not the UAE with whom there has been a falling out.
The likeliest reason is leadership. Having failed to convince the rest of the OPEC+ gang to avoid any easing of quotas, Saudi Arabia could be wanting to prove its position by providing a measure of supply security at a time of major price sensitivity due to the Covid-19 resurgence. It will also provide some political ammunition for future negotiations when the group meets in March to decide plans for Q2 2021, turning this magnanimous move into an implicit threat. It could also be the case that Saudi Arabia is planning to pair its voluntary cut with field maintenance works, which would be a nice parallel to the usual refinery maintenance season in Asia where crude demand typically falls by 10-20% as units shut for routine inspections.
It could also be a projection of soft power. After isolating Qatar physically and economically since 2017 over accusations of terrorism support and proximity to Iran, four Middle Eastern states – Saudi Arabia, Bahrain, the UAE and Egypt – have agreed to restore and normalise ties with the peninsula. While acknowledging that a ‘trust deficit’ still remained, the accord avoids the awkward workarounds put in place to deal with the boycott and provides for road for cooperation ahead of a change on guard in the White House. Perhaps Qatar is even thinking of re-joining OPEC? As Saudi Arabia flexes its geopolitical muscle, it does need to pick its battles and re-assert its position. Showcasing political leadership as the world’s crude swing producer is as good a way of demonstrating that as any, even if it is planning to claim dues in the future.
It worked. It has successfully changed the market narrative from inter-OPEC+ squabbling to a more stabilised crude market. Saudi Arabia’s patience in prolonging this benevolent role is unknown, but for now, it has achieved what it wanted to achieve: return visibility to the Kingdom as the global oil leader, and having crude oil prices rise by nearly 10%.
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