Currently work at an oil major as a software engineer. Getting recruiters to poach me for trading desk developer positions which are pseudo quant since I'll be working on building pricing models for derivatives based of crude/gas/power. But given commodities is highly fundamental. driven purely through supply & demand, and is usually illiquid due to it's nature of moving vast product from A to B, has anyone ever developed quant arbitrage opportunities? I figure best bet would be in either Gas or Power markets since they're the most liquid. Curious to hear more from those in the commodities side. Personally would like to make the switch from commodities to more liquid derivative classes like Fixed Income.
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Based on the most helpful WSO content, quantitative strategies in commodities trading, while less common than in equities or fixed income, do exist and are evolving. Commodities are indeed heavily influenced by supply and demand fundamentals, but there are areas where quant strategies can shine:
Geographic Arbitrage: As highlighted in discussions, price differences in commodities across regions due to supply/demand imbalances create arbitrage opportunities. For example, crude oil prices can vary based on pipeline supply or refinery setups. Quantitative models can help identify and exploit these spreads, provided transportation costs are factored in.
Gas and Power Markets: These are among the most liquid commodity markets, making them more suitable for quantitative strategies. Power markets, in particular, have unique characteristics like hourly pricing and weather dependencies, which can be modeled using advanced statistical techniques.
Risk Arbitrage in Physical Trading: Quantitative models can optimize logistics, transportation, and storage costs to capture P&L opportunities. For instance, traders use models to determine the most cost-effective way to move physical commodities while hedging risks with derivatives.
Shift Towards Quantitative Implementations: As noted in discussions, there is a growing trend of incorporating quantitative methods in commodity trading. While many traders may lack advanced programming skills, firms are increasingly valuing those who can analyze large datasets and build pricing models.
If you're considering a move to more liquid derivative classes like Fixed Income, your experience in building pricing models for derivatives in commodities could be a strong asset. Fixed Income markets also rely on quantitative strategies, and your skills in programming and model development would be highly transferable.
Sources: Physical Commodity Trading, Quantitative Analysis and Probability in Trading (Market Makers, HFT, Quant Firms), Ask me anything - quant/quantamental Hedge fund manager/Consultant - Everything on liquid hedge fund strategies, Trading Power, Carbon & NGOs, Calling all Physical Commodity TRADERS: Benchmark indices and physical commodity trading risk
Wouldn't "the best bet" be in more illiquid markets, so NOT gas or power? Arbitrage is fundamentally about finding market inefficiencies and exploiting those. Liquid markets are more efficient at price discovery so it's much more difficult finding arbitrage opportunities.
Unfortunately no, because illiquid means more in person deals and you can model it out using math & stats and then code up an algo telling you when to buy and sell, but then the problem becomes there are no people willing to do business at the spat out prices. So quant algos can only be applied whenever there are lots of players and liquidity. The other problem is that illiquid in commodities means not only are there fewer players in the game, it also means that it costs more to transport the product from A to B. It's nearly instantaneous to move gas across a pipeline or power across the grid. The one way to find arbitrage that I know of for gas for example is tracking the flow of gas across state lines and having knowledge of which gas flows within a state since interstate gas flow doesn't have to be reported anywhere publicly.
I know for example that Citadel does a lot of business in nat gas due to it being the most liquid commodities market and they're one of our counter parties that we middlemen deals for.
I disagree that commodities are driven solely by the S&D. Futures and cash do eventually converge based on supply and demand but price action in the interim can be driven quite a bit by things like market structure, order flow, and macro.
Could you elaborate more? Like sure those things can impact it, but how much liquidity is there? From my experience the biggest drivers of commodities prices are weather, wars/geopolitical conflicts, and production rates. I thought interest rates would've had a huge impact on commodities but the impact isn't as great as one would think. Lmk if I can PM you to learn more.
Depends on the commodity, power is seen as the more quantitative commodity. I know where I’m at, we do have a quantitative algo strategies to trade power which boil down to either forecasting generation/demand to predict prices or some pairs strategy.
In terms of “traditional quant”, commodities market making is where you want to go. I’m not too familiar with it but back in my previous place, the department was making options markets in Oil and Gas.
Oil and Gas Trading Desk Developer usually involves just automating Supply and Demand Balances, Data Scraping/Engineering or just building Dashboards. The most quantitative you’re going to get is usually Time Series Modelling usually with Monthly Data ( this results in mainly just using General Linear Models). At best, you’ll be working in algo-signal models based on the manipulation of price data and perhaps supply and demand data much like power.
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