The Hindu Business Line : IT's money in oil

When is it easy to certify a product or even vouch for it? It depends on whether you are the vendor of the product or its user. A user would necessarily bring in objectivity. But if you have been on both sides, objectivity comes easily, but importantly, with insight. That's what eWorld found in its chat with Baburaj Parakkal, who was till recently with California Software (CalSoft) and is now with its parent Chemoil Corp as Global IT Director and is a user for one of CalSoft's packages - Analytica, a business intelligence tool. His colleague S Venkatramana from the Risk Management team that sits in Chennai joined us. Excerpts from the conversation:

First, a few words about Chemoil. It trades in oil. It buys oil in bulk and sells it in bulk, (cargo trading) as well as to the retail market (bunkering).

It sources from South America, West Asia and from Asia and sells predominantly in the US, with a presence in four major ports there, including the Panama. It also has presence in Rotterdam, Europe.

In oil trading, companies make money through time or location arbitrage. That is, a company buys oil at a point in time, and sells it later at a higher price, assuming that the price rises in the market. Or it could buy at one location and sell at another where the prices are higher. Alternatively, it could blend different kinds of oil to arrive at a certain quality and make more money per unit of oil than it spent per unit on the whole.

On the bunkering side, customers are more or less fixed. There are commitments to purchase from the oil company, which knows how much it has to supply. In cargo trading, we identify cargo customers and enter into term contracts with suppliers based on market prices, availability and the like.

Parakkal says, "What happens here is that we are exposed to prices. There is a time lag and a difference in location which makes you vulnerable to market dynamics." Oil companies tend to carry a lot of oil inventory either on water or in the tanks. This `inventory' that a company carries could be exposed to market price fluctuations.

In the oil markets, prices are volatile all the time. Parakkal explains, "It's a future sale or purchase. Normally, we don't enter into a fixed price sale - it's always a floating price - based on some parameters such as the five days' average or one month average because both the buyer and seller want to minimise risk from price fluctuation."

Here's where the `trader', an employee of a typical oil trading company, plays a critical role. He takes decisions based on the information at hand. Information that could be raw or which comes out of a business intelligence tool all shaped up to make his task easier.

Decision dilemmas for traders

In some cases, the nature of the deal forms a natural hedge against risk. Say you have to sell a cargo of 300,000 barrels in 10 days' time. If you can find a vendor who would be able to meet the price, you will be able to minimise price fluctuation. Purchase commitment would also be based on those 10 days' price movement and sales are split over 10 days. So the oil company doesn't have to do a hedge otherwise.

But this is the ideal case and need not happen every time, says Venkatramana. "There will be instances when you have to go for Swaps, Futures or Auctions. The first two are most actively used. Swaps are exchanges of cash flows, among operators such as Chemoil."

In other words, a swap is a purely cash settlement. It is much like a borrower opting to shift to a floating loan rate for his housing loan from a fixed rate.. End up paying cash outflow once you shift from one to the other."

But information is available to all operators - so how do you make money in a swap?

Venkatramana agrees and says that in some instances there won't be any buyer for a swap. So, in such a scenario, "You will have to go to the exchange and do a futures transaction, which index has got more correlation to your markets."

When does a trader opt for a swap? Is there an ideal situation for it?

Says Venkatramana, "Our inventory is at risk. If the market price for oil falls by $2, I'd lose millions overnight. On any day we should know what our total risk is - that is the critical component in our decision making. Second, what is the total value that I derive from inventory I am carrying. If I am able to sell at a certain price, what is the approximate realisation that I can make? We call that `mark to market'. We track these two measures. A lot of information goes into tracking these two. One is the actual, physical deals. All the physical deals that have taken place go into the system. It starts from inventory - a sum of all quantities we have at all the ports. Then we have information on the purchases that are incoming - whatever the status, whether they are on water, or have been loaded from a port, or unloaded as yet. Then we have committed sales - fixed customers who would already have determined how much they want - contracts would have been signed. Based on these, we would know where we stand on a daily basis."

Data that is captured daily comes from various agencies - stock markets in geographies Chemoil is present in and from the forward/future markets. "Now, we would know the future prices for November, December and January for each index and each port." So, that we get thanks to lots of activities in the derivatives market - we feed all the information in the system and then Analytica generates the daily report, which traders and the management in our company use to take decisions.

Apart from that, Analytica gives traders incidental reports. The net exposure the company has with various agencies through its swap arrangements is critical data for the trader. Incidental reports throw up such data.

As to trading itself, what decisions does data trigger? Chemoil buys oil and sells it. With the quantum and delivery date fixed what are the levers that Chemoil has to increase profits, or reduce loss?

Venkaramana explains: The focus is more on barrels at risk, how much inventory you have - data from system. Looking at that, past trends, pricing, at each port, current price at each port, the trader minimises risk. Based on that data we provide, they would decide and know what future market conditions are. These are all the future prices across exchanges, November, December and January data is published and you know price will go up. The traders take a decision on how many paper deals they will have to do. Sometimes they will decide not to do a paper deal.

Traders also take decisions sometimes to divert stock while it is en route to a port. If prices rise at another port, it makes sense to sell your stock there, even allowing for excess logistics costs.

Says Venkatramana, "Daily reporting helps here - value of cargo getting loaded is a critical input. The moment they see it losing or gaining value, they decide to move to another port or even sell it midway. When we sell to bunker, we could also do `blending' - we blend different quantities to result in different quality. If we see blending not giving benefits, then we might as well sell it as cargo."

The risk management group here adds value to the trader in the form of information.

Data critical for futures and options

Parakkal explains, "Let's say you purchase cargo of 300,000 tonnes - at a price that is one month's average in November. You want to minimise risk."

The trader wouldn't know how it would move, but is comfortable with the $38-40 range. Based on quantity and price movement trends, the trader would do a deal where he would fix purchase price, say, at $ 40 a barrel. Let's say the one-month average comes to $42 a barrel, while the swap deal says $40. So the trader gains $2 or a total of $600,000.

If the price drops to $38, the trader would pay $40 for the swap deal. "End result is that you would more or less pay the same. That's the decision that the trader makes. If he doesn't do it, and if the price falls to $35 from $40, then you lose $5 per barrel," says Parakkal.

He adds, "The Scorecard sheet is a daily report we send to traders. Before the new system, they used to have access to the same data through disparate sources and multiple reports in the form of Excel sheets.

There was no drill down facility that could throw up insights from different layers of data. Analytica helps them with that through a graphical representation.

From the management perspective, if one wants to know how much profit a particular trader makes and under what heads, that is immediately available. What we have is we would club a set of deals together. A trader made a purchase (physical), entered into a swap (paper), bought the oil and sold it as cargo. You can compare all three and see how much money the trader made under each head.

Finally, Chemoil didn't have to junk its old system since Analytica sits on top. A trader needs a database as well as a business intelligence tool that would throw up graphs on historical trends - such as month-wise or index-wise, says Parakkal. These are critical for him to make an estimate of what would happen in the future.

"Typically, we commit to purchases for the next three months. Purchases are to be made based on term contracts or tenders. Similarly, now, we want to hedge it for the next three months. We can take a position today itself but to take that decision, a trader needs to know how the market would behave for the next three months. He would have first-hand information from brokers. Apart from that he should also have access to historical data."

Management would also find the tool useful to narrow down on a particular customer if he has not been buying as much from us as he was last year. The system we have now does not offer us that, says Parakkal.

The tool also has potential for datamining. Parakkal says, "We are not looking at it now. But once we start using it, there are ways in which we can achieve this. For instance, we could look at whether a customer is picking up the bunker in a particular port? Even though the price was low at a different port, he still picked up the stock at that port. Then maybe we can sell it at a premium at that port x maybe they have some affinity for that. We would again have the volume they bought and the average price they bought it at, at that port."

Parakkal says inventory management is the key to profitability in the bunker business. In the past, inventory data was monitored once in 24 hours.

With Analytica, it has become possible to have a real time access to inventory positions across the globe. We expect this to greatly enhance the quality of our procurement and sales decision-making with a commensurate positive impact on profitability.

In addition, we anticipate savings of around 10-20 per cent in the operational cost of report generation because of the Analytica deployment.

Previously, report generation involved significant manual intervention, which impacted both productivity as well as accuracy of the data.

bharatk@thehindu.co.in

Illustration: K.B. Jawaharr

More Stories on : Software | Software | Petroleum | User Watch

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page