8 Economists' Investment Tips
She Jianyue: “The Logic of Oil Prices” -- Three Price Differences in the Crude Oil Market
Summary of this issue
· Analyst dilemma
· Three spreads closely linked to fundamentals
· A relationship model between commodity fundamentals and three types of price differences across regions
What's in this issue
Now let's look at a question about price theory. I personally prefer to concentrate on doing one thing, so for a while I went through a lot of economics textbooks. I usually like to read the catalog first to see how different each textbook is compared to other textbooks.
I later discovered that in Western economics, all microscopic price theories are similar and slightly different. The core thing is a very ideal price world. The basic rule is that the supply of goods increases as the price rises, which is a proportional relationship; the quantity of demand decreases as the price rises, which is an inverse relationship.
So theoretically speaking, if we can find a pair of supply and demand curves, one is directly proportional and the other is inversely proportional. They will definitely intersect. The quantity of supply in the intersecting location is equal to the quantity of demand, and at the same time, it will also produce a very perfect balanced price. This is the most important microprice model foundation in Western economics textbooks, and it is also a conclusion that can be drawn based on the laws of supply, demand, and price.
I think in practice, this model is actually flawed, so why assume that supply will equal demand? When have we seen a product's supply exactly match its demand? Very difficult. The real world is definitely not an ideal world of prices. The real world is actually also very simple; isn't it just that reduced supply and demand equal inventory? Inventory must be ubiquitous, and inventory cannot be left undiscussed.
Some people say it wrong. Inventory is actually sometimes a kind of supply, sometimes a kind of demand. Increased inventory can be understood as an increase in demand, and a drop in inventory can be understood as an increase in supply. Doesn't this just return the problem to its initial state? I think this is very awkward because dualistic relationships seem simple, but it's also easy to get caught up in a kind of self-entanglement called catch-all logic.
So I think it's great to extract the three elements of fundamentals and find a very clear relationship between them. That is, reduced supply equals inventory.
When we study products, when we study supply-demand balance sheets, aren't we just doing this? However, from a quantitative perspective, we hope to be able to count today's supply and demand, and then obtain changes in inventory. We prefer to predict future supply and demand, then we can know the future balance between supply and demand. If we determine that supply exceeds demand, we will go short; if supply is in short supply, we will go long. We love to analyze things from a quantitative perspective.
But here's the problem. Maybe there's a small product that everyone can do in detail, but if you take a look at the crude oil product, is it possible to predict future supply and demand? It's very difficult; anyway, I think it's very difficult to predict. The US inventory data is detailed enough, is the forecast accurate? Some US companies use infrared imaging to monitor the pump room of the pipeline, check the liquid level of the fuel tank through drones, and then determine whether this week's inventory should rise or fall. But is this forecast accurate? Nor was it approved. The same goes for our stuff; doing statistics from a quantitative perspective is very problematic.
A metaphor I really like to use is the analyst's dilemma. What does that mean? A car is parked in the garage, and you check the mileage every day at 12 o'clock. Suddenly I ask you to draw the speed curve of this car yesterday. Can you draw it? I can't draw it.
The only thing you can do is use the mileage you recorded today to subtract the mileage you recorded yesterday. For example, the result is 100 kilometers, then divide by 24 hours to get yesterday's average speed, and then draw a map. Although the average speed is equal to the area below the actual speed curve because the amount of integration is equal, the average speed does not reflect the actual situation at all.
If you want to judge the current situation of the balance between supply and demand from a quantitative perspective and predict the future, this is the plight of meter readers. This is not OK. What to do? Can't we do a qualitative analysis first? It's possible. Qualitative analysis converts quantitative indicators into price indicators; why should they be converted to price indicators? Because we trade prices every day, and prices happen every moment, our data source is very timely and adequate.
I also did some arbitrage transactions for a while, so I had some contact with price spreads, because arbitrage is essentially a spread. I sorted it out later. Our commonly used arbitrage models correspond to the three types of spreads. Of course, there are others, but I found these three spreads very interesting (the most important).
The first spread is the so-called interperiod spread. The interperiod spread is the difference between spot and futures, which is a kind of spread over time. There are also price differences between futures contracts for different delivery months, and of course they may not, but most of the time there are. I will summarize this type of price difference as the first type of price spread, called interperiod spread. In textbooks, it also seems to be called interperiod spread.
The second price difference is the price spread across regions, that is, the price difference between similar products in different regions. In this textbook, it is called cross-market price difference.
The final price difference is the cracking price difference. In textbooks, I like to call it cross-product price difference. The cracking price difference is the price difference between products and raw materials. I define it this way.
All three spreads are used by traders in their daily arbitrage transactions. For example, cross-regional arbitrage, where is the item cheaper? I bought it and sold it to a place with a higher price. Did I use the cross-regional price difference? Anyone who has played futures knows how to play positive and negative sets. What is a positive game? Buying spot goods, hoarding them, and throwing them out at a higher price on the futures market is called a proper package. What do you profit from? It depends on the price difference between spot and futures. Of course, it may also fail; for example, the market price is not high enough.
You can also do the opposite. First, sell the oil in stock. If forward-term Shanghai crude oil futures are cheaper than in the Middle East, sell the inventory and then refill the stock in the future, then make up the stock in the future, what is used here is the price spread over time. I don't know if anyone has done the cracking price difference. Anyway, as oil traders, for example, we may lock in the cracking price difference of diesel when processing incoming materials. Why? Because if the price difference between diesel and crude oil is very high, it means that processing is very effective, right? If the price of refined oil was much higher than the raw material, I would probably lock it down.
Therefore, these three spreads are commonly used by us in trading, but we haven't figured it out, or we haven't taken the initiative to think about what kind of fundamentals we are doing this, and what kind of feedback effect it will have on the fundamentals after doing it. So later, I made a correlation between price differences and supply, demand, and savings. I hope in the future this will be a standard model. This model is a model of the relationship between the cross-regional fundamentals of commodities and the three types of price differences.
This model has two characteristics. First, the products here are not a balance sheet; they must be zoned. The commodity market cannot be solved by using a balance sheet, so I proposed crossing regions.
The second characteristic is that the three elements of supply, demand, and inventory were changed from measuring quantity to measuring price differences.
The three price differences correspond to supply and demand, respectively. First, cross-regional price differences represent a region's marginal supply capacity. It's very simple. If there isn't enough supply in the region, it can only be imported; if there is an oversupply, it will be exported, right? This is a rigid thing, so trade across regions changes supply in a region. Cross-regional spreads represent marginal supply. They respond very quickly and are very flexible. Why? Because our traders only want profit, we can start trading as long as there is a price difference and profit, so it must be a marginal supply force.
Second, what is the price spread index corresponding to demand, or how do we look at the intensity of demand? Actually, just look at the cracking price difference. If the price difference of cracking is huge, for example, the price difference between refined oil products and crude oil is very large, there must be a good demand for oil. This is easy to understand.
I really like to use bread and flour as an example. If the price of bread were ten times 100 times the price of flour, the downstairs would be full of bakeries today. It must be like this. Can't the demand for flour be bad? The same goes for oil, so we can use the cracking spread to measure the intensity of demand. You can look at the current intensity, and you can also deduce its future changes. If the current difference in gasoline's cracking price is good, you must know that it will definitely not be good in the future, why? Because there is excess refining energy around the world, if the cracking price difference of gasoline is good, all refineries will increase gasoline production, then after increasing production for a limited period of time, gasoline will become surplus.
Don't tell me that global refining is insufficient; there will be another explanation (note: in the case of insufficient refining capacity, good demand for refined oil products will cause cracking price differences to skyrocket). The prerequisites and results correspond one by one, and the logical mechanism is the same.
The third is inventory. Inventory is the result of a balance between supply and demand. If supply exceeds demand, inventory will rise; if supply is in short supply, inventory will fall. So which indicator measures the intensity of the rise and fall of inventories? It's an interperiod spread. Can you imagine why would you want to increase your inventory in a normal situation? Because it is beneficial to stock up, you will continue to increase your inventory. It's not that you only stock up if you think oil prices will rise in the future; it's impossible.
If supply exceeds demand, but does not provide you with a proper set of profits, then the market does not really exceed demand. Therefore, when you discover that supply will exceed demand in the market in the future, you must also know that regular profits will definitely improve; logically, this corresponds one by one.
This is the logical relationship between fundamentals and spreads. In fact, we are exposed to these price differences on a daily basis, but we haven't integrated them into a whole. After integrating them into one whole, this system will be helpful for strategy construction, understanding price fluctuations, and even understanding the fundamentals as a whole.
That is the content of this course, thank you all.
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