Oil: Play Brent’s appreciation through foreign exchange rates - Natixis

Analysts at Natixis note that since the agreement reached by OPEC producers on 30 November 2016, Brent has resumed its ascent, setting a high at $57/bbl at the start of January 2017.

Key Quotes

“We expect Brent to extend its rise to $66/bbl come the end of 2017, fuelled by a reduction in both OPEC and non-OPEC supply along with an increase in global demand.”

“In light of this scenario, we set out below a strategy for playing this rise in the price of Brent (as an alternative to conventional hedging instruments on Brent) through the foreign exchange market. We propose putting together a basket of currencies to play a rise in the price of Brent, therefore via the foreign exchange market (or as a way of hedging exposure to Brent). Many currencies, in particular those of oil exporting countries, are very highly correlated to the price of Brent. Furthermore, most of them offer a positive carry.”

“By contrast, hedging exposure through crude oil futures is very costly given that the oil futures curve is very steep (contango). Hedging exposure through options on a basket of currencies would therefore be more cost effective than entering into crude oil futures. The crux of the matter lies in approximating as finely as possible the fluctuations in the price of Brent in relation to this basket of currencies.”

“On this basis, currency pairs selected one year ago using this methodology are the USD/CAD, USD/RUB and USD/COP, all petrocurrencies, i.e. the currencies of oil exporting counties. After one year, this weighted basket displays 71% correlation against Brent.”

“Our current calculation reveals that the composition of the basket would be unchanged, i.e. still comprise the USD/CAD, USD/RUB and USD/COP.”

“Finally, the carry for the basket is highly lucrative (value 17 January 2017) especially compared with crude (for which carry is negative), while the cost of the call for the basket is less than the cost of the call for crude, which suggests that the use of currencies as a proxy for crude is attractive.”