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THE FUNDAMENTAL ANGLE METHOD
By: Brynne Kelly

To increase your EDGE trading Energy and Commodity futures, take a cue from the fundamental analysis and research
methods that have been used in the Equity markets for years to determine the valuation of a listed company. Taking
this approach will allow you to not only weed out Headline Noise, but also identify high probability opportunities.

Energy and Commodity futures represent prevailing market prices for an expansive set of business activities that include
supply, demand and logistics similar to stock prices. Focusing on only one driver will hang you out to dry almost every
time. Research and analysis has successfully been used to identify gaps in market valuations and profit from them.

With over 20 years managing portfolios for large, integrated energy companies I have intuitively been applying
fundamental analysis and research to every commodity I trade.

In this report, I share with you the process I use to evaluate the economic and competitive drivers in Energy and
Commodity markets. The following approach will kick-start your ability to identify and even get ahead of developing
trends. With a little up-front effort you will develop a process for information seeking and gathering that will pay off.

Here is the Method I use to create my edge:

1. Identify the Economic Drivers of Price and the contract parameters of the product you are trading (be
thorough, dont rely only on easily obtainable headline news like inventory reports)
a. Define the Scope of the market
b. Define the Industry contract parameters of the product you are trading
c. Identify key regional price relationships
d. Identify key global price relationships
2. Identify the Competitive Aspects of the Industry
a. Define relationships to, or dependencies on, other prices or business activities
b. Define the key producers and consumers of the product and the storage system that that links them.
3. Define items that can singularly change price levels and those that influence price levels cumulatively over time.
4. Track and evaluate prices and relationships daily.
5. Constantly seek to expand or revise items on your list!

*****SEE EXAMPLE APPLICATION IN THE FOLLOWING PAGES

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Example Application: WTI Crude Oil Futures (CL) Cushing, OK

(**using published market prices from February, 21 2017)

1. Economic Drivers of Price and Contract Parameters Step 1

a. Scope of the Market Step 1(a)

With minimal research you will discover that the Crude Oil complex has over 500 distinct global crude pricing hubs
representing crude oil from all parts of the globe. However, this large and varied group of crude grades relies heavily on
just a handful of markers, or benchmarks, within them.

The Benchmarks:

Brent Blend Roughly 2/3rds of all crude contracts around the world reference Brent Blend, making it the most
widely used marker of all. Currently, Brent actually refers to oil from four different fields in the North Sea:
Brent, Forties, Oseberg and Ekofisk (BFOE). Norways Troll crude will be included in the blend starting Jan 2018.
Crude from this region is light and sweet, making them ideal for the refining of diesel fuel, gasoline and other
high-demand products. Because the supply is water-borne, its easy to transport to distant locations and is used
in pricing sales for Europe, the Mediterranean, Africa, Russia and Australia. (Underpinning this benchmark is
another, more significant contract called Dated Brent. This contract is a benchmark assessment of the price
of physical, light North Sea crude oil. The term "Dated Brent" refers to physical cargoes of crude oil in the
North Sea that have been assigned specific delivery dates.)
Dubai/Oman This Middle Eastern crude is a useful reference for oil of a slightly lower grade than WTI or Brent.
A basket product consisting of crude from Dubai, Oman or Abu Dhabi is somewhat heavier and has a higher
sulfur content, putting it in the sour category. Dubai/Oman is the main reference for sales into Asian market.
West Texas Intermediate (WTI) WTI refers to oil extracted from wells in the U.S. and sent via pipeline to
Cushing, OK. The fact that supplies have been relatively land-locked has been one of the drawbacks to West
Texas crude its relatively expensive to ship to certain parts of the globe. WTI historically has been the
benchmark for sales into North and South America.

These benchmarks are traded via futures contracts, forward physical and forward swap contracts. As a result, firms may
have positions on their books made up of both contracts that can be netted against one another up until expiration
(delivery) through the use of EFP (exchange of Futures for Physical) or EFS (exchange of Futures for Swaps) products on
an exchange. These two products allow market participants to manage their net price exposure to a benchmark and
close-out gross long/short positions in different contract types against one another.

(Note: While the use of Brent and Dubai benchmarks far exceed that of WTI in global crude oil contracts, they are all
priced in USD.)

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Now that you have defined the major Crude Oil benchmarks, create a table to capture daily published settlement Prices
available from all exchanges. Futures contracts for the major benchmarks are usually listed on more than one exchange,
with each one having its own, unique settlement characteristics. The CME and ICE are two of the exchanges that list
contracts for these benchmarks and publish daily settlement prices.

(Example Table 1)

*(source: https://www.theice.com/marketdata/reports/10)

Legend:
M1 = Prompt Futures Contract
nd
M2 = 2 Prompt Futures Contract
M1-M2 = The level of contango (neg. number) or backwardation (positive number) in the market
M1 yr/yr = The 1 year spread of the Prompt Futures Contract (Apr-7 versus Apr-8 in this case)

With this simple table, you are immediately oriented to the relationship among benchmarks as well as the individual
term structures of each curve. Tracking prices daily will allow you to identify changes in these relationships.

Spreads between Benchmarks

As noted earlier, WTI and Brent are defined as a Light Sweet crude oil grades while Dubai has a lower API density and
higher sulfur content than WTI or Brent. Spreads between these benchmarks are an indication of global supply, demand
and logistics. You can see the relative market values between them in the spread columns of the table.

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WTI/DUB and BRN/DUB:

Due to the difference in API and sulfur contents, these spreads can give you an idea of the refining demand for specific
grades of oil (WTI/DUB and BRN/DUB). Note that WTI is trading below Dubai oil for M1 and M2 (expressed as a negative
number).

Spreads between benchmarks can also define the global movements of crude oil. The front WTI/DUB spread indicates
how competitive WTI-based crudes are in Asia or how likely Dubai-based crudes are to head into the US West Coast
(which then impacts Alaskan North Slope crude prices).

WTI/BRN:

The WTI/Brent spread impacts the incentive for movements into and out of the US Gulf Coast (USGC) as oil is attracted
to the highest price. Over the past few years, Brents premium (to WTI) began to wane and WTI-based crudes started to
lose their economic advantage against Brent-based crudes making waterborne imports more attractive for US refiners.
However, as we will cover in the upcoming Regional Benchmark step in this process, there is a more useful spread to
gauge USGC import/export economics (namely, LLS/BRN spread since LLS -Louisiana Light Sweet- prices reflect the cost
to ship WTI barrels to the USGC).

USGC refiners have in recent years been importing increasing volumes of heavier crude oil as this type of crude oil is not
a majority of the US shale production boom equation and, depending on refinery margins, may at times be more
economical to run in complex refineries like those in the US Gulf Coast.

Calendar spreads

Since a common link between future contract terms is storage, calendar spreads indicate the level of storage incentive in
the market. Contango (neg. #s in the above table) and Backwardation (positive #s in the above table) can exist at any
price level meaning that it is about the relationship of prices rather than price itself. Storage barrels are attracted to
markets that are in steep contangos. The term structure of the market plays a role in the determination of inventory
levels in the physical markets as a strong contango supports the accumulation of inventories and the selling of them
forward. The flattening of the term structure then will eventually cause accumulated inventory to be released.

Using the values from our table above you can see that the WTI market currently holds the most storage premium:

To further facilitate the price transparency of the cost of storage, the CME also lists a storage futures contract based on
crude oil storage capacity at the LOOP Clovelly Hub (Louisiana Offshore Oil Port) for USGC sour crude oil. This will be
discussed further under Step 2b.

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b. Define the Contract Parameters of the product you are trading Step 1(b)

Crude oil is differentiated by Grade and by Location. Grades are referred to as follows:

High Low
API Density "Light" "Heavy"
Sulfur Content "Sour" "Sweet"

WTI crude oil is classified as a Light Sweet grade of oil. Specifications as defined by the CME Nymex Rulebook are
(https://www.cmegroup.com/rulebook/NYMEX/2/200.pdf):

A NYMEX WTI futures contract contains detailed instructions about delivery stating that it must occur at Cushing, OK
into a pipeline or storage facility during the delivery period. Any pipeline deliveries made in the US domestic crude oil
market for a particular month have to be scheduled by the 25th day of the month prior to actual delivery (or the closest
business day before the 25th).

The WTI contract is defined as Sellers Choice. This means that the seller designates whether the delivered crude
stream shall be domestic or a specific foreign crude oil stream as well designate a qualified incoming pipeline or storage
facility. In addition, in the event that a Federal U.S. Superfund tax and/or Oil Spill tax is in effect at the time of delivery
for foreign crude oil, the buyer shall reimburse the seller for all such taxes that have been or will be paid by the seller.

Beyond futures, a common clause in physical supply contracts includes the concept of Force Majeure. The purpose of
a force majeure clause is to release (or suspend) a party from its contractual obligations upon the occurrence of an
event beyond its control. I mention this because, at some point along the chain, physical supply is sold into the futures
market meaning someone takes the risk between physical contract delivery contract parameters and futures contract
parameters.

c. Identify key regional price relationships Step 1(c)

Now that we have defined the 3 major benchmarks used for global crude oil pricing, its time to drill down into the
Regional (or local) influences within each benchmark.
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The WTI market is characterized by a large number of independent producers who sell their crude oil to gatherers based
on posted prices for their specific grade and location. The oil is then brought into Market areas and directed either
towards the Gulf Coast refining areas, towards Cushing, Oklahoma for storage or to other regional refining and
processing areas.

WTI prices at other US benchmark locations (main refining centers) in general are based on the Cushing deliveries plus
the respective pipeline costs to those centers. The relative level of discount for WTI versus the USGC simply reflects the
shifting parity point where these crudes physically interface with each other. Spreads between WTI, Brent and LLS
reflect the interface of offshore supplies coming into the region, setting the prices in Louisiana and Houston area
destinations

Key regional Benchmarks in the US and Canada are:

*Source: http://www.argusmedia.com/mkting/argus-forward-curves-services/crude-oil/

As with the global oil benchmarks, you will want to create a table to capture several of the regional benchmark futures
prices:
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(Example table 2)

(Example table 3)

Now you have an understanding of how the various regional benchmarks are priced relative to one another.
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Global benchmark spreads impact regional spreads and vice versa. For example, weakening of front-month WTI against
Brent tends to lift regional cash crude differentials, particularly for light, sweet grades, which compete with Brent-based
imports.

Its also important to look at Spot prices and relationships since they are often times the first indicator of changing
relationships and trends. The table below gives you an idea of the spot market volume in various regional grades of oil

The eia.gov website posts daily crude oil cash prices for the benchmarks WTI, Brent and LLS. In addition, refiners and
gatherers across the country post their daily crude oil bulletins indicating the prices they are willing to pay for various
crude grades in the US.

Spot market trades are bilateral transactions between buyers and sellers of physical crude oil for short-term delivery.
Tracking posted cash prices not only gives you an indication of how spot market supply/demand factors are playing out,
but also creates a reference database for average monthly cash prices.

Lets take a look at Eagle Ford Bakken crude oil prices and the cash spread to WTI (WTI/BAK in Table 4). While
production of Eagle Ford continues to rise and find new buyers amongst US refineries, the quality of Eagle Ford remains
inconsistent due to geological issues. Texas refiners reported a variance in the quality of Eagle Ford from 42 to 60
degrees. Most spot Eagle Ford trades use LLS as the basis, and the spot price of LLS provides a better reflection of US
Gulf Coast supply and demand fundamentals for light, sweet crude than light, sweet crude oil delivered from West and
North Africa. You can see this pricing issue highlighted in Table 4.
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(Example table 4)

*Source: https://www.eia.gov/todayinenergy/prices.php and https://www.fhr.com/products-services/fuels-and-aromatics

Legend:
Dark Green = Monthly average of Daily Prices
Row dates = Daily posted cash price for that days delivery

(Example table 5)
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In addition, this allows you to see the consistency of spreads between the various grades in the cash markets and identify
any deviations that might carry forward in to the futures market.

With the data compiled so far, there are already a lot of good comparisons to make. An example of this can be seen in
Bakken prices. The futures strip prices for Bakken crude are for oil derived from the Bakken shale formation that are
injected into the Enbridge pipeline at Clearbrook, MN via lateral gathering lines, yet the spot posting price from refiners
and gatherers is related to the well-head location. The difference highlights the cost of transportation out of the region to
the pipeline. Something to keep in mind watching the news regarding the Dakota Access Pipeline play out.

d. Identify the key global price relationships Step 1(d)

By now, you are starting to see which relationships are more volatile and which relationships have greater impact on
WTI futures prices. Producers and Refiners are always looking for the highest price for their product and will move them
to the market with the most value whenever possible. Examples of these relationships include:

WTI/Brent Relationship

Historically (prior to 2010) these two crudes of similar (light sweet) quality enjoyed a close pricing relationship governed
by the U.S. need to import light sweet crude to meet domestic demand with Brent trading at a slight discount to WTI
mostly reflecting freight costs. Huge increases in domestic light crude production from shale have changed the
relationship since 2010 including a WTI discount to Brent averaging $18/Bbl during 2012 as new production was
stranded at Cushing. Spreads at that level provided the financial incentive to construct a lot of new pipeline capacity
from Cushing to the Gulf Coast.

LLS/Brent Relationship

The Gulf Coast is home to roughly 50% of US refining capacity and a traditional hub for light sweet crude oil imports.
The two key benchmark prices for light sweet crude in the Gulf are Brent and LLS. The ability to move shale production
out of Cushing and into the Gulf has a direct impact on prices of both Brent and LLS. The LLS/WTI and LLS/Brent spreads
indicate movements of imports and exports in the region. A wide LLS/WTI spread relative to LLS/Brent will favor moving
bbls from Cushing to the Gulf for refining or export. A wide LLS/Brent spread relative to LLS/WTI will favor importing
Brent bbls for refining.

2. Identify the Competitive Aspects of the Industry Step 2

a. Define relationships to, or dependencies on, other prices or business activities Step 2(a)

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Since crude oil is generally not directly consumed in its raw form by anyone other than refiners, the
value of crude oil comes from the value of the products into which it can be refined.

The margin for refining crude oil into gasoline and heating oil is expressed as the Crack Spread in the market. Hence the
prices of these products tend to be highly correlated to movements in crude oil. For one side of the complex (crude oil)
to move significantly without the other (products) generally requires a shift in the margin expectations the market is
willing to give to refiners and is highly impacted by supply/demand factors of the products themselves.

These spreads are very valuable to track as they contain a lot of information regarding logistics, seasonality and
supply/demand balances.

(Example table 6)

*Source: https://www.theice.com/marketdata/reports/144
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The HOGO spread referenced above refers to the difference between New York Harbor Heating Oil prices and
Rotterdam Gasoil prices. Because Heating Oil is priced in $/gallon and Gasoil is priced in $/Metric tons the spread is
calculated using a 3:4 contract ratio in order to achieve volume parity. This spread helps determine which market refiners
will choose to deliver their finished product to.

Another interesting piece of the puzzle is to review Refinery Netback reports to see the spreads being realized by refiners
relative to the Crack spreads in the futures market:

As is the case of most commodities, understanding the paper market, logistics and shipping is key to
many successful strategies, which evolve around the arbitrage of locational prices. Refiners around the world are always
in search of the highest margin for their products. If they can obtain a better margin by exporting, local prices either have
to rise to keep the products in the country or the relative prices at the export location will eventually come down as supply
floods into that market. Understanding these relationships will give you an advantage in your positioning and will even
open up the world of spread trading within the Petroleum complex. You begin to understand that the market is much
more than weekly inventory reports. Headline oversupply news should be evaluated against the many spread
relationships (locational and term structure), spot market prices (including refinery posting prices) and refining margins to
asses any impact beyond market sentiment.

Locational arbs are key to determining the flow of oil and its products around the world.

b. Define key producers and consumers and the storage system that that links them Step 2(b)

Production:
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Consumption:
According to the EIA, the United States consumes more energy from petroleum than from any other energy source. In
2015, total U.S. petroleum consumption was about 19 million barrels per day (b/d), the equivalent of about 36% of all the
energy consumed in the United State.

This consumption breaks down as follows:

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Total world consumption of petroleum in 2014 was about 93 million b/d. The five largest petroleum-consuming countries in
2014, and their share of total world petroleum consumption are: United States (21%), China (12%), Japan (5%), India
(4%) and Russia (4%)

Driven by the US shale revolution and restructure in world refining industries, global oil trade is shifting towards the
East. Asia-Pacific has become the world biggest oil consumer and refinery center, and also the largest target market of
crude oil. In addition, the Asia-Pacific holds the worlds largest refining capacity.

Seasonality:

Seasonality influences crude oil prices under normal supply and demand conditions. But compared to geopolitical
tensions, supply levels, or prevailing economic conditions, the seasonality factor could have a minor effect.

The over-riding seasonal supply/demand influences on crude oil prices tend to focus on summer driving season and
refinery turnaround seasons. Turnarounds are scheduled events at a refinery in which the plant closes down for an
extended time for operations and inspections. This generally has an impact on both the crack spreads and the term
structure of the futures curve. In markets where crack spreads are high, turnarounds tend to be deferred as long as
possible. This has been the case the past year or so as refining margins were the savior for many integrated oil
companies.

Turnaround season has typically resulted in a reduction in demand for, and large builds of, crude oil as refining capacity
is reduced. However, with the new Export abilities in the US, it remains to be seen how these barrels could move to
refiners in other countries that are not on the same turnaround schedule as the US if spreads are economic.

There are many estimates out there that forecast the Planned Spend for turnarounds in 2017 will be up 50% from last
year levels. Turnaround seasons are often times associated with the narrowing of contango between the month(s)
preceding the season and the month(s) in the season.
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Storage:

US Inventory levels have been a topic of much discussion and headline news. To avoid getting caught in an inventory-
level hype trade, its important to put some context around the issue.

The petroleum complex is an operational system that consists of production, refining and consumption whose life-cycle
is much shorter than that of traditional goods manufacturing. Once the 'consumption' takes place the process starts
over so there needs to be immediate replacement of supply in the refining system.

THIS is the differentiator.

What we experienced in 2014/2015 was a rapid increase of inventory levels in the overall system above and beyond the
norm. This resulted in a fear that production would overwhelm the system beyond it's capacity and the market sold off
accordingly

In reality, while we have seen inventory levels sustain at higher levels since then, there have been measures taken that
have kept us from exceeding capacity including production cuts and additions to overall storage capacity (especially in
the Gulf Coast).

Looking at the weekly EIA Inventory report, it becomes more important to focus on the percent Utilization of the
system capacity:

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Digging further into the the utilization rate of system capacity, its important to understand the what level of capacity we
are utilizing. Below is the growth in US Crude oil storage capacity:

Its normal to expect that as world-wide consumption expands with population growth, etc. so must the storage capacity
of the system. One could argue (with much disagreement) that the expansion of storage capacity was to meet a growing
overall global system versus an oversupply of production.

LOOP Crude Oil Storage futures:

Regardless of its success, the importance of storage capacity to the overall production and refining system is evidenced
by the introduction of the CME LOOP (Louisiana Offshore Oil Port) crude oil storage futures. This contract is based on
crude oil storage capacity at the LOOP Clovelly Hub, LA.

3. Define items that can singularly change price levels and those that influence price levels cumulatively over
time Step 3

Transportation:

The Petroleum complex relies heavily on transportation by rail, pipeline and ship to move crude oil and products to the
markets with the highest value. Changes in transportation rates or disruptions in transportation capacity can have
immediate impacts on short-term prices. Some examples of this are:

Colonial Pipeline is the largest US refined products pipeline system that carries more than 3 million bbls of
gasoline, diesel and jet fuel between the US Gulf coast and the New York Harbor area. Disruptions on this
pipeline have historically led to large and swift price movements
Cushing take-away capacity - expansions that increase the ability to move shale production in the north through
Cushing and on down to the Gulf Coast (watch the WTI/LLS spread on this one)
New pipelines or pipeline expansions
o Keystone XL pipeline, once built could transport 830,000 bbls/day of crude oil from Alberta, Canada into
Cushing, OK that was previously being moved by more expensive rail transport. This Canadian oil is
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primarily a heavy, sour grade that Gulf Coast Refineries use and therefore will compete with or displace
Mexican and other crudes coming into the Gulf (watch Argus ASCI sour index on this one)
o Dakota Access Pipeline, one built could transport 470,000 bbls/day of crude oil from the Bakken shale
region to the oil tank farm in Pakota, IL. Currently around 70% of Bakken crude is moved by rail car
which is more expensive.
Spreads between prices in the US Gulf coast and those on either the East or West Coast

Currency Rates:

Since the global crude oil complex is priced in US dollars significant strengthening or weakening of the US Dollar relative
to other currencies can impact outright crude prices. The strength of the Euro relative to the USD in 2008 had this type
of effect on crude oil prices.

Examples of other items:

Renewables legislation (i.e. RINs and Ethanol blending requirements to meet CO2 standards)
Adoption of electric vehicles
NGL prices (represents other income sources from bbls produced)

(Example table 7)

Commodity Index benchmark adjustments (i.e. GSCI Commodity Funds)

Example Index benchmark adjustment headline (Reuters, 2/27/17):

On Friday - for the first time in six years - a rule in one of the most popular commodity market indices was
triggered, requiring funds tracking the index to sell Brent crude futures contracts for December LCOZ7 and to
buy contracts for June LCOM7. The S&P GSCI Enhanced Commodity Index rule aims to ensure that investors are
positioned to cash in when oil market fundamentals change. An S&P bulletin late Friday confirmed the rule had
been triggered for Brent contracts. It stipulates that the funds must bring their money forward if the second and
third month contract settles at a difference of less than 0.5 percent on the third to the last day of any given
trading month.

Items will be continuously added and removed to this list. The key is to identify them and include or remove them in
your daily analysis.

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4. Track and evaluate prices and relationships daily or weekly Step 4

Now that you have identified the global and regional price benchmarks as well as the relationship to various product
prices, you will be able to focus in on the key prices you should track daily or weekly to help you identify trends.

I follow a rigorous process of updating my price tables daily for key benchmarks and weekly for certain regional
benchmarks. If I find that certain prices arent relevant any more, I drop them off my list. Having managed energy
portfolios for a variety of large, integrated energy companies I can tell you that the most important information is the
relationship of prices. I rarely spent time staring at individual price charts for any other reason than a historical look at
where prices have been.

One of the values of creating price tables is that you become intimately familiar with price levels and enhance your
memory in the process

The good news is that most information is readily available without an expensive market data subscription. At a
minimum, exchanges are required to publically post settlement prices for all of their listed and cleared products. All it
takes is a little context to pull it all together.

5. Constantly seek to expand or revise items on your list Step 5

As you move up the learning curve with the knowledge base you are building, you will quickly be able to identify new
price drives into your model. It will also help you evaluate the cost/benefit of investing in access to other exchanges or
markets where some of the supporting characters to the benchmarks are traded. Knowing all of the characters in the
story is beneficial to understanding the whole story.

This Overview using WTI crude oil as an example is intended to help you get started in applying the Fundamental Angle
Method to your analysis of the commodity you are trading. This type of analysis can be even more powerful when
applied to products that are more regional such as US natural gas and electricity markets. There is tremendous
opportunity for you by creating your own information edge!

Copyright 2017 Brynne Kelly

Not For Republication Anywhere

@BrynneKKelly on Twitter