Issue 29

Tuesday August 9, 2011

Flashpoint: Crude Oil Inventories and Price

Reactions
By Erik Skyba, CMT
SeniorQuantitativeAnalyst,TradeStationLabs
TSLabs@TradeStation.com

Summary
EveryWednesdayat10:30a.m.Easterntime,energytradersanalyzeandreacttothe
headlinesoftheU.S.EnergyInformationAdministration(EIA)PetroleumStatusReport.
ThisreportprovidesinformationonpetroleumproductinventoriesintheU.S.,including
thoseforproductsproducedhereandabroad.Thepopularnotionisthatchangesincrude
oilinventorieshelpestablishshorttermcrudeoilprices.Inthispaper,weanalyzethis
relationshiptodeterminehowthesechangesincrudeoilinventorylevelsaffectcrudeoil
prices.Whatwediscoveredwasnotwhatweexpected,butwasneverthelessimpressive.

This issue
9 Focus:
Fundamental
9 Markets:
Futures
9 Time Perspective:
Short-term
9 Studies/Files Included:
Strategy
Workspace
EIA data

Note:AlltimesreferencedinthispaperareU.S.Eastern.

Introduction
Tradersathedgefundsandproprietarytradingdesksthatfocusontheenergysectorpay
verycloseattentiontotheEIApetroleumheadlinesthemomenttheyhitthetape
(http://www.eia.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_
report/current/pdf/wpsrall.pdf).Thesetradershaveordersqueuedtoexecutethemoment
theyinterprettheheadlines.Theheadlinesaretypicallyhighlightedandlooklikethisin
theNewswindowofyourTradeStationplatform(Figure1).
Figure1DowJonesNewsinTradeStationPlatform(EIACrudeOilStock,InventoryData)

Note:TheWeeklyPetroleumStatusHighlightsReportisasummaryofimportantchanges
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inthedata.
Thetimeofdaywhentheweeklypetroleumstatusreportisreleasedhasvariedovertheyears.Inthe1980s,the
datawasreleasedat5p.m.eachWednesday.Inthe1990s,theEIAmovedthetimeslotto9a.m.,andinthespringof
2003,itmovedthetimeto10:30a.m.Inthe1990s,attherequestofmajornewsservices,theEIAdecidedtohavea
setpolicyonpublicationrelease,whichitfollowstothisday.Thatis,ifthereisaMonday,TuesdayorWednesday
holiday,itwillpublishthereportonedaylate;ifthereisaholidayonaThursdayorFriday,thepublicationreleaseis
unaffected.

Analysis - EIA Crude Oil Inventory Data vs. Crude Oil Prices
Beforewebeganourstudy,wetheorizedthatjustlikethepriceofanyothergoodorservice,crudeoilpricesare
determinedbysupplyanddemand.Thatis,duringperiodsofstrongeconomicgrowth,onewouldexpectdemandto
berobust.Ifinventoriesdecrease,thiswillleadtoincreasesincrudeoilprices.Ifinventoriesincreaseduringstrong
economicgrowth,pricesmaynotbeaffected.Duringaperiodofsluggisheconomicactivity,demandforcrudeoil
maynotbeasstrong.Ifinventoriesareincreasing,thismaypushcrudeoilpricesdown.Weanalyzedcrudeoil
pricesusingafiveminuteCrudeOilContinuousCompositeContract,focusingonWednesdaystrading,from10a.m.
to11a.m.(Figure2).ThetickersymbolforthiscontractintheTradeStationplatformis@CL.C.Thissymbol
includesbothpitandelectronictradingforthetimeperiodbetween10a.m.and11a.m.,goingbacktoMay2003.
WeexaminedcrudeoilpricesgoingbacktoMay2003fortworeasons.First,wedidntknowtheexactdatesand
timeswhentheEIAbeganreleasingitsdatapriortoMay2003,asmentionedearlier.Thesecondreasonisthat
CrudeOilContinuousCompositeContracthadarobustdatabasebeginningin2003.
Figure2@CL.CFiveMinuteInterval,CrudeOilContinuousContractComposite,10a.m.11a.m.

Inordertoincorporatethecrudeoilinventorydatainourtesting,wedownloadedtheWeeklyU.S.EndingStocks
excludingSPRdata(http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCESTUS1&f=W)fromthe
EIAwebsite.Thisdatacouldthenbechartedas3rdPartydatainTradeStation.(Formoreinformationoncharting
3rdPartyDatainTradeStationandforalistoffilesavailablefromTradeStationLabs,please
emailTSLabs@TradeStation.comandrequestinformationonourStatisticsLibrary.)
Therearemanywaystotestthecauseandeffectrelationshipbetweencrudeoilinventoriesandcrudeoilprices.
Whenitcomestomeasuringtheseeffectsonshorttermtradingincrudeoilprices,itmakessensetocomparecrude
oilinventorylevelstotheirpriorweekvalues.Thischangecaneitherbeapositiveornegativenumber.Barring
whereweareintheeconomiccycle,ifthechangeispositivethenaninventoryriseshouldtheoreticallyputpressure
oncrudeoilprices,atleastintheshortterm.Anegativechangeshouldcausecrudeoilpricestorise.Inthispartof
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ourstudy,wewantedtomeasuretheeffectsoncrudeoilpricesafterthe10:30a.m.releaseoftheEIAinventorydata.
OurtraderulesforthisstudysaidthatiftheEIAinventorydatawasgreaterthanlastweeksnumber(differenceis
positive),thensellshortonecrudeoilcontractattheopeningofthe10:30a.m.barandcoverthepositionxnumber
ofbarslater.IftheEIAinventorydatawaslessthanlastweeksnumber,thenbuyonecontractofcrudeoilatthe
openingofthe10:30a.m.barandsellthepositionxnumberofbarslater.InFigure3,wecanseetheperformance
resultsusingtheserules.
Noteworthy performance, highlighted by the yellow boxes, indicates that the best overall performance (long and
short trades) came within five minutes (10:35 a.m.) of the release of the EIA inventory number. Crude oil prices
reacted negatively to increases in inventory levels, with the best short performance occurring between 10:40 a.m.
and10:55a.m.Decreasesininventorylevels,however,didnothavethereverseeffectofincreasingprices,aslong
tradeshadnegativeperformanceforallfiveminutebarsfrom10:40a.m.to11a.m.
Figure3PerformanceResultsComparingOilInventoriestothePriorWeek(resultsdonotincludecommissionand
slippagecosts)

Whenexaminingtherelationshipbetween afundamental oreconomicnewseventandaparticularassetclass,we

typicallyplotthecumulativereturnsofthesecurityasittradedaroundthetimeofreleaseofthenewsevent.Wedo
thistogetafeelforhow,onaverage,thesecurityspricetradesaroundthereleaseofanewsevent.Inthisstudy,we
analyzedoneyearofcumulativepricechangesofcrudeoilreturnsbetween10a.m.and11a.m.,onthedaythatthe
EIA inventory data is released. In Figure 4, using the crude oil continuous contract (@CL.C), we see cumulative
simplereturnaverages,forthatperiodoftrading,onanannualbasisfromMay2003tothepresent.Thisanalysisis
helpfulinvisualizingchangesintherelationshipofasecurityandaparticularnewsevent.
Thispatterntowhichwedrawyourattentionwasnotsoobviousatfirstglance.ButasFigure4shows,theturning
pointsincrudeoilarefairlyapparent.Withtheexceptionof2003,thereisanobviouschangeinpricemovement
between10:30a.m.and10:40a.m.Eitherthepriceofcrudeoilrunshigherintothe10:3010:40a.m.periodorit
sellsoffintothisperiod.Thischangeinshorttermpricetrendisrightaroundthetime ofthe EIAinventory data
release.ThechangesinpricetrendarecircledinFigure4.
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Figure4YearlyCumulativeSimpleReturnAverages,10a.m.11a.m.,May2003Present

Without concerning ourselves with the cause of this price behavior, we can test these observations by once again
statingsomesimplerulesaboutthepricemovement.Ifthecumulativepercentagereturnfrom10a.m.to10:30a.m.
isbelowzero,thenbuyontheopenofthe10:30a.m.barandsellthepositionxnumberofbarslater,until11a.m.at
thelatest.Ifthecumulativepercentagereturnfrom10a.m.to10:30a.m.isabovezero,thensellshortontheopenof
the10:30a.m.barandcoverthepositionxnumberofbarslater,until11a.m.atthelatest.Figure5demonstrates
theresults.

Figure 5 Performance Results Rules: Cum Return < 0 Ten Buy and Cum Return > 0 Then Sell Short, May 2003
Present(resultsdonotincludecommissionandslippagecosts)

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Notice that overall net profit (Long & Short Trades Cum Return < & > 0 column) increases as the 11 a.m. bar
approaches.Thehighestnetprofitof$34,410wasreachedinthe11a.m.hour.Seventythreepercentofthatprofit
wasderivedfromshorttrades,whichamountedto$25,050innetprofit.Shorttradesperformedbetterthanlong
trades,thoughalllongandshortexitswereprofitable(10:3511a.m.).
Figure6isanexampleofwhatanequitycurvelookslikeusingtheserules(longandshorttrades)alongwiththe11
a.m.barexit.AswecanseeinFigure6,theequitycurvemovedsidewaysuntilaround2007.Fromthatpointtothe
present,theequitycurvehasbeenmovinghigher.Itisimportanttonotethattheequitycurvesformostoftheexits
hadafairlysimilarshape.
Figure 6 Strategy Performance Report, Equity Curve Detailed Long and Short Trades Using the 11 a.m. Exit, One
ContractTraded,May2003Present(resultsdonotincludecommissionandslippagecosts)

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Conclusion
Thefirstsetofruleswestudiedinthispapercomparedtheweekoverweekchangeincrudeoilinventories.Prior
toourtesting,wepostulatedthatifinventoriesrose,wewouldseeshorttermweaknessinthepriceofcrudeand
viceversaifcrudeoilinventorieswerelower.Ofcourse,thisviewdidnottakeintoconsiderationtheeconomic
cycle.Theresultsforthemostpartwereinconsequential,thoughtradersmightbeinterestedinlongandshort
tradesinthefirstfiveminutesaftertheEIAreleasesitsnumbers,aswellasallbarexitsbetween10:40a.m.and11
a.m.forshorttrades.Consistentprofitabilityinbothlongandshorttradesforthefirstfiveminutesafterthe
inventorydataisreleasedmakessense,especiallyastraderswhotradeoffthesenumbershaveashorttermbias
becausetheyaretradingthenewsevent.
Thefirstfiveminutesoftradingistheonlyexitperiodthatshowedprofitabilityforbothlongandshorttrades.
WhatisintriguingforlongtradesisthatassoonastheEIAinventorynewshitthetape,profitabilitydecreased
(Figure3).Withshorttrades,profitabilityheldsteadyuntilabout10:50a.m.Whenwereviewshorttradesfrom
thispartofthestudy,itisverydifficulttosaywhytheydidbetterthanlongtrades.IfwereferbacktoFigure4,you
willnoticeyearswhencrudeoilreachedahigharound10:30a.m.andproceededlowerinto11a.m.,butthisprice
behavioronlyoccurredin2007,2008and2009.Furtheranalysiswouldberequiredtodeterminewherethebulk
ofprofitsforshorttradescamefrom.
Inthesecondpartofourstudy,wetestedatradingpatternthatwerecognizedincrudeoilpricesthatoccurred
between10a.m.and11a.m.(Figure4).Theserulesexhibitedpositivevalueforbothlongandshorttradesoverall.
Onceagain,shorttradeshadbetterperformancethanlongsandthepercentageoftradesprofitableaveragedabout
50percent.AlthoughtheEIAinventorydatareleasewasnotincorporatedintheserules,onewonderswhateffect
thereleaseofthisdatahadoncrudeoilpricesbetween10a.m.and10:30a.m.onWednesdays,priortothedata
beingreleased.Whatwedoknowisthatforeveryotherhourwetested(910a.m.,noon1p.m.,etc.)usingthese
exactrules,performanceresultsrevealedmorerandomreturns.Sothereisdefinitelysomethinggoingonwith
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respecttotherelationshipbetweencrudeoilandinventories.Wecouldreasonthatcrudeoiltradersspeculatein
concertbeforethenumberisreleased,inthattheybuy(sellshort)leadinguptothenumberandthensell(cover)
onthenews,themomentithitsthetape.Butasweshowedinthefirstpartofthestudy,thisrelationshipis
tenuousforlongtrades,withtheexceptionofthefirstfiveminutesaftertheinventorydatawasreleased.Aswe
mentioned,shorttradeswereprofitableforallfiveminutebarsuntil11a.m.
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