Oil Traders are constantly looking for opportunities to profit from dislocations in oil pricing which can be of various natures, such as geographical dislocations or dislocations relating to time periods.

With geographical dislocations, traders look to profit from sourcing oil products in one region, then move them to sell in another region where prices are high enough to cover their costs and deliver a profit. Because of the physical constraints of moving oil, there is significant risk in trying to capture these arbitrages if traders are not hedging. In order to carry out these trade, a life cycle of the trade can look like the following:

• Source physical oil
• Charter vessel to carry physical oil
• Sail vessel to another region in the world
• Unload vessel and deliver products

Assuming a trader is not hedging, the main risk here is price changes in the delivery region whilst the oil is in transit.

If the oil is unhedged, then whilst the oil is onboard the vessel, the trader is effectively long, so is exposed to the price of the outright oil at the delivery location moving up or down and if prices move down then they could end up losing money on the trade.

To hedge, the trader needs to identify the contracts and tenors that most accurately reflect the location and times that they will be buying and selling the oil and of course the specification of the oil they are moving. In practice, traders will often use these “differential” prices in the derivatives market to make decisions on regarding physical arbitrages as it’s crucial to be able to lock in their profits before booking the physical transactions.

Example:

Trader in Singapore observes that the Diesel market in Europe is very strong and has the idea of shipping Diesel from Singapore into N.W.E. to sell to a European trader who has storage in Rotterdam. Let’s say the trader notes that the transit time is around 30 days, so he will be selling product in the month after it departs Singapore and therefore incurring a time spread risk as well as a geographical risk.

The trader observes in the paper market that buying Diesel in Singapore on a MOPS 10ppm basis in December 2024 and selling Diesel on a ICE Gasoil Swap basis in January 2025 has a differential price of -$30.00/MT (Singapore is $30/MT less than Europe). His logistics costs are around $23.00/MT leaving him with a $7.00/MT net profit.

He has the opportunity to book a vessel that can carry 300,000 barrels or roughly 40,000 tonnes of Diesel (using 7.45 conversion factor), so he asks Onyx Markets for a price on the differential between December 2024 MOPS 10ppm Gasoil and January 2025 ICE Gasoil Swap for 40,000 tonnes.

If the trader has booked the vessel, then after executing the hedge through Onyx Markets, he is protected against the sourcing and selling of his physical diesel and will be protected against any adverse price moves while the oil is in transit, as well as the changes in price between December and January. If the trader had just executed both legs of the trade on a December 2024 contract, then these contracts would expire before the oil had discharged, and therefore would be at risk of prices coming off and losing money on the trade.