Ilia Bouchouev

Research Associate

Dr. Ilia Bouchouev is the former President of Koch Global Partners where he launched and managed global derivatives trading business for over 20 years. Over the years, he introduced several energy derivatives products and was recognized as one of the pioneers in energy options trading.

He is currently managing partner at Pentathlon Investments and adjunct faculty at New York University where he teaches energy trading at Mathematics in Finance Master Program at Courant Institute of Mathematical Sciences.

He has Ph.D. in Applied Mathematics and published in recognized journals on derivatives pricing and energy markets. Dr. Bouchouev serves on the editorial board of Quantitative Finance.

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                    [post_content] => Russia’s renewed interest in hedging its oil export revenues has sparked an old debate on whether macroeconomic policies to mitigate the consequences of commodity price volatility, such as establishing revenue stabilization funds to smooth government expenditure over time, should be augmented (or even substituted) by the use of financial instruments such as futures and options. Mexico’s experience in hedging its oil exports is often used as an example of a successful case that other producers could follow.

This is not only related to the issue of macroeconomic stabilization, but also as to whether the use of such financial instruments can enhance producers’ competitive advantage in oil markets and provide them with added flexibility and additional tools to manage the market. For instance, many have argued that Mexico’s hard stance during the OPEC+ talks in April is directly related to the fact that it had a hedging programme in place. Also, while the world’s biggest producers such as Saudi Arabia, Russia and other OPEC producers possess a comparative advantage in terms of their lower cost of production and hence ability to compete in a low price environment, North American producers have a different kind of advantage in their ability to hedge production forward and potentially lock in higher prices than OPEC+ members could get for spot barrels when the market is in contango. Thus, there have been some suggestions that OPEC+ should consider new tools to influence the shape of the curve, including selling oil forward to push prices downward along the futures curve and discourage small US shale producers from hedging.

In this short Comment, we review the results of the main case study in this area, the large-scale put option buying programme administered by the Government of Mexico and assess whether such a programme can be replicated in Russia. We also discuss whether other low-cost producers could potentially also consider participating in the growing market for oil derivatives and in what ways. We argue that Mexico’s experience is unique in many respects and that Russia and other oil producers with large volumes of production and pricing power face serious limitations in replicating Mexico’s experience. We also find that any direct replication of the Mexican hedging programme at today’s market prices does not make much economic sense for Russia. Buying the hurricane insurance the day after the hurricane is unlikely to be good idea. This does not imply though that Russia and other oil producers should not develop their capabilities and participate more actively in derivatives markets. However, this takes time and requires building institutional, legal, financial, and trading capabilities and developing unique strategies that complement (and do not disrupt) their existing policies and are reflective of their size and influence in the oil market.
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                    [post_content] => The long-term impact of the Covid-19 crisis on various industries, including oil trading, remains highly uncertain. While some uncertainties, such as the magnitude of the demand destruction for petroleum products and the pace of global storage saturation are known unknowns, other consequences could come as a shocking surprise. It is very unlikely that any of us could have foreseen WTI ever trading at negative 40 dollars, and the critical role that retail-oriented derivatives products played in such historic event. To better understand what happened with the recent behavior of WTI, this Comment analyses how financial participation in oil markets evolved over the last decade, particularly the rise of the retail investor and the role of Exchange Traded Funds (ETFs) in the historic event of oil prices dropping to negative $40 on the day before the expiry of May WTI futures.

The Comment argues that while long-only ETFs always provide significant downward pressure on prompt WTI contracts as traders sell in anticipation of the product rolls, these funds did not have anything to do with negative pricing.  Also, contrary to often cited opinions, this episode was not directly caused by well-documented storage issues in WTI contract delivery location. The lack of storage was indeed the catalyst that started the fire. Subsequently, large ETFs, including USO, added some fuel to it by rolling their massive positions and pressuring May WTI by the middle of April. But the actual explosion and subsequent $60 collapse in a single day down to minus $40 was caused by small cousins within ETF family, which happened at the time when all large market participants already left the contract.

Longer term, a growing appetite among smaller retail investors to participate in the market supported by easier access to trading platforms and modern technology does not appear to be going away. Even fifteen years of losses by financial oil investors have not been able to eliminate the paper demand for oil. Financial engineering will adjust and make products better, but they are unlikely to disappear anytime soon and tracking their positions becomes as important to oil analysts as tracking fundamental balances.

As such, investors ongoing inflows will likely increase opportunities for US producers to place forward hedges at levels which can still ensure reasonable longer-term returns. Somewhat ‘irrational’ behavior among retail investors effectively subsidizes producer hedging and could delay fundamental market rebalancing if producers choose to take this opportunity and to hedge, instead of making more rational decisions to cut production. Ironically, one wrong business model prevents the other one from getting better at least until the invisible hand of free markets punishes both.

The Comment concludes that the sharp blow inflicted by the collapse of May contract will not be repeated given some additional safeguards which have been put in place by dealers improving systems to handle negative prices, by prime brokers raising initial margins, by regulators asking funds to reduce positions, and by funds themselves rolling out of prompt WTI contract earlier. But ongoing dull pain inflicted on both investors and oil producers is there to stay longer.
                    [post_title] => The Rise of Retail and the Fall of WTI
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            [post_content] => Russia’s renewed interest in hedging its oil export revenues has sparked an old debate on whether macroeconomic policies to mitigate the consequences of commodity price volatility, such as establishing revenue stabilization funds to smooth government expenditure over time, should be augmented (or even substituted) by the use of financial instruments such as futures and options. Mexico’s experience in hedging its oil exports is often used as an example of a successful case that other producers could follow.

This is not only related to the issue of macroeconomic stabilization, but also as to whether the use of such financial instruments can enhance producers’ competitive advantage in oil markets and provide them with added flexibility and additional tools to manage the market. For instance, many have argued that Mexico’s hard stance during the OPEC+ talks in April is directly related to the fact that it had a hedging programme in place. Also, while the world’s biggest producers such as Saudi Arabia, Russia and other OPEC producers possess a comparative advantage in terms of their lower cost of production and hence ability to compete in a low price environment, North American producers have a different kind of advantage in their ability to hedge production forward and potentially lock in higher prices than OPEC+ members could get for spot barrels when the market is in contango. Thus, there have been some suggestions that OPEC+ should consider new tools to influence the shape of the curve, including selling oil forward to push prices downward along the futures curve and discourage small US shale producers from hedging.

In this short Comment, we review the results of the main case study in this area, the large-scale put option buying programme administered by the Government of Mexico and assess whether such a programme can be replicated in Russia. We also discuss whether other low-cost producers could potentially also consider participating in the growing market for oil derivatives and in what ways. We argue that Mexico’s experience is unique in many respects and that Russia and other oil producers with large volumes of production and pricing power face serious limitations in replicating Mexico’s experience. We also find that any direct replication of the Mexican hedging programme at today’s market prices does not make much economic sense for Russia. Buying the hurricane insurance the day after the hurricane is unlikely to be good idea. This does not imply though that Russia and other oil producers should not develop their capabilities and participate more actively in derivatives markets. However, this takes time and requires building institutional, legal, financial, and trading capabilities and developing unique strategies that complement (and do not disrupt) their existing policies and are reflective of their size and influence in the oil market.
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Latest Publications by Ilia Bouchouev