Exploring Seasonality in Crude Oil Prices
What rises, must fall. What comes down, goes up again. This rings most true for crude oil prices. Both secular and seasonal trends are at play in crude oil prices.
Demand for oil moves in tandem with global economic activities. Key secular trends impacting oil markets over this decade was covered in our previous paper. These range from falling demand from developed markets, and rising demand in emerging economies, among others.
While secular trends unravel over a longer time, seasonal cyclical effects can be observed over a short term.
This paper will explore consumption patterns driving annual seasonality in crude oil prices. In Part two of this paper, we will illustrate trading crude oil derivatives to harness opportunities arising from seasonality.
CRUDE OIL SUPPLY CHAIN: AN OVERVIEW
Gluts and shortages, economic growth and contractions, and geopolitics impact crude oil prices. Different events impact various segments of the supply chain. The global crude oil supply chain is complex and intricate. It can broadly be classified into Upstream, Midstream, and Downstream.
Upstream and midstream sectors drive crude oil supply. Upstream outage or shortage affects available supply which are sometimes evened out by the midstream through adequate inventories.
Downstream and midstream drives demand. End consumer demand is observed in distribution. Refineries adjust output based on their margins which in turn is derived from crude oil prices and refined product prices.
WHAT DRIVES SEASONALITY?
Seasonality in demand for refined products impact crude oil prices. Higher demand for refined products (gasoline, diesel, and kerosene) is observed in summer because of travel. While lower supply is caused by maintenance linked pauses in downstream during winter.
Crude oil inventory shifts can be segmented into four phases, namely: (1) Inventory Build Up (Feb - May), (2) Summer Travel Spikes Demand (Jun - Aug), (3) Demand Shrinks & Supply Contracts (Sep - Nov), and (4) Winter led demand spike (Dec - Jan).
This seasonality is evident in US crude oil inventory shifts as exhibited below.
Impact of seasonality is not always directly apparent or predictable. Why? Crude oil is so deeply intertwined with global economics. Shocks, if any, can have an outsized impact on prices and volatility. Also, supply cuts from majors oil producers and GDP shifts in major consumers have jumbo effect on prices. Consequently, other factors moderate or nullify impact of seasonality.
The below chart shows the average price behaviour of Crude oil from the start of each year over the past twenty (20) years by using CME front month crude oil futures price data from TradingView.
Orange bars in the above chart represents average monthly price change measured over last twenty years. Meanwhile, the white bar shows monthly price change for the same period but after excluding the outliers. Outlier years include 2008 (global financial-crisis), 2020 (pandemic), and 2022 (Russia-Ukraine conflict).
Crude prices go bullish on higher demand by refineries starting in March and continue to rise through the summer months as demand for refined products remains high driven chiefly by increased travel.
However, by August, sufficient refined product inventories dampen demand. With refineries slowing for maintenance, crude demand declines leading to a moderation in price. Finally, a small uptick is observed in December as demand starts to rise again during peak winter.
The average monthly returns for each month are displayed below. However, note that the standard deviation for these averages is non-trivial indicating that month-of-the-year effect on crude oil prices is uncertain and, in many cases, statistically insignificant. This conclusion is also arrived at based on various academic research papers.
METHODS TO HARNESS CRUDE OIL SEASONALITY
Three most common methods to harness gains from seasonality include: a. Futures (highest upside and highest downside), b. Call options (upside limited relative to futures and limited downside risk), and c. Call and/or Put Spreads (limited upside and limited downside).
Traders can deploy options to express a directional view with unlimited upside and limited downside. In a long options position, the downside is limited to the premium paid.
Conversely, a short position in options involves selling an option. This offers upside limited to the premium collected but exposed to unlimited downside.
TRADE SET UP ILLUSTRATIONS
From July until November, based on historical observations over the last twenty years, crude oil prices tend to fall. We could set up a trade using the December contract month of CME Micro Crude Oil Futures which expires on Nov 17th:
1. Short Futures: Short Futures position in MCL Dec 2023 contract (MCLZ3) at USD 70 per barrel with the anticipation that prices will fall by November.
2. Long Puts: Long Put options on MCLZ3 at a strike of USD 69 per barrel with a hypothetical options premium of USD 3 per barrel.
3. Bear Call Spread: Bear Call Spread with a net premium of USD 1 per barrel on MCLZ3 comprising of a short call option at a strike of USD 71 a barrel (collecting options premium of USD 5 per barrel) and a long call option at a strike of USD 73 a barrel (paying options premium of USD 4 per barrel).
The Bear Call Spread profits a fixed amount equal to the net premium when both options expire out of the money. When only the short call options expires in the money, the position loses by having to pay the options buyer. However, when both options expire in the money the profit from the long option partially offsets this loss resulting in a capped downside.
Each CME Micro Crude Oil Futures contract represents one hundred barrels of crude oil. Accordingly, the above three trade set ups are illustrated across various price scenarios as shown below.
Please note that these illustrations do not include (a) transaction costs comprising of exchange trading and clearing costs and brokerage fees, and (b) capital costs associated with margins required for establishing these positions.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Demand for oil moves in tandem with global economic activities. Key secular trends impacting oil markets over this decade was covered in our previous paper. These range from falling demand from developed markets, and rising demand in emerging economies, among others.
While secular trends unravel over a longer time, seasonal cyclical effects can be observed over a short term.
This paper will explore consumption patterns driving annual seasonality in crude oil prices. In Part two of this paper, we will illustrate trading crude oil derivatives to harness opportunities arising from seasonality.
CRUDE OIL SUPPLY CHAIN: AN OVERVIEW
Gluts and shortages, economic growth and contractions, and geopolitics impact crude oil prices. Different events impact various segments of the supply chain. The global crude oil supply chain is complex and intricate. It can broadly be classified into Upstream, Midstream, and Downstream.
Upstream and midstream sectors drive crude oil supply. Upstream outage or shortage affects available supply which are sometimes evened out by the midstream through adequate inventories.
Downstream and midstream drives demand. End consumer demand is observed in distribution. Refineries adjust output based on their margins which in turn is derived from crude oil prices and refined product prices.
WHAT DRIVES SEASONALITY?
Seasonality in demand for refined products impact crude oil prices. Higher demand for refined products (gasoline, diesel, and kerosene) is observed in summer because of travel. While lower supply is caused by maintenance linked pauses in downstream during winter.
Crude oil inventory shifts can be segmented into four phases, namely: (1) Inventory Build Up (Feb - May), (2) Summer Travel Spikes Demand (Jun - Aug), (3) Demand Shrinks & Supply Contracts (Sep - Nov), and (4) Winter led demand spike (Dec - Jan).
This seasonality is evident in US crude oil inventory shifts as exhibited below.
Impact of seasonality is not always directly apparent or predictable. Why? Crude oil is so deeply intertwined with global economics. Shocks, if any, can have an outsized impact on prices and volatility. Also, supply cuts from majors oil producers and GDP shifts in major consumers have jumbo effect on prices. Consequently, other factors moderate or nullify impact of seasonality.
The below chart shows the average price behaviour of Crude oil from the start of each year over the past twenty (20) years by using CME front month crude oil futures price data from TradingView.
Orange bars in the above chart represents average monthly price change measured over last twenty years. Meanwhile, the white bar shows monthly price change for the same period but after excluding the outliers. Outlier years include 2008 (global financial-crisis), 2020 (pandemic), and 2022 (Russia-Ukraine conflict).
Crude prices go bullish on higher demand by refineries starting in March and continue to rise through the summer months as demand for refined products remains high driven chiefly by increased travel.
However, by August, sufficient refined product inventories dampen demand. With refineries slowing for maintenance, crude demand declines leading to a moderation in price. Finally, a small uptick is observed in December as demand starts to rise again during peak winter.
The average monthly returns for each month are displayed below. However, note that the standard deviation for these averages is non-trivial indicating that month-of-the-year effect on crude oil prices is uncertain and, in many cases, statistically insignificant. This conclusion is also arrived at based on various academic research papers.
METHODS TO HARNESS CRUDE OIL SEASONALITY
Three most common methods to harness gains from seasonality include: a. Futures (highest upside and highest downside), b. Call options (upside limited relative to futures and limited downside risk), and c. Call and/or Put Spreads (limited upside and limited downside).
Traders can deploy options to express a directional view with unlimited upside and limited downside. In a long options position, the downside is limited to the premium paid.
Conversely, a short position in options involves selling an option. This offers upside limited to the premium collected but exposed to unlimited downside.
TRADE SET UP ILLUSTRATIONS
From July until November, based on historical observations over the last twenty years, crude oil prices tend to fall. We could set up a trade using the December contract month of CME Micro Crude Oil Futures which expires on Nov 17th:
1. Short Futures: Short Futures position in MCL Dec 2023 contract (MCLZ3) at USD 70 per barrel with the anticipation that prices will fall by November.
2. Long Puts: Long Put options on MCLZ3 at a strike of USD 69 per barrel with a hypothetical options premium of USD 3 per barrel.
3. Bear Call Spread: Bear Call Spread with a net premium of USD 1 per barrel on MCLZ3 comprising of a short call option at a strike of USD 71 a barrel (collecting options premium of USD 5 per barrel) and a long call option at a strike of USD 73 a barrel (paying options premium of USD 4 per barrel).
The Bear Call Spread profits a fixed amount equal to the net premium when both options expire out of the money. When only the short call options expires in the money, the position loses by having to pay the options buyer. However, when both options expire in the money the profit from the long option partially offsets this loss resulting in a capped downside.
Each CME Micro Crude Oil Futures contract represents one hundred barrels of crude oil. Accordingly, the above three trade set ups are illustrated across various price scenarios as shown below.
Please note that these illustrations do not include (a) transaction costs comprising of exchange trading and clearing costs and brokerage fees, and (b) capital costs associated with margins required for establishing these positions.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
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