“The oil futures market is completely broken. Moving down $10 in a day for no apparent reason,” tweeted hedge fund celebrity Pierre Andurand this week. Indeed, volatility these days is not what it was just a couple of years ago. Yet it may be a little excessive to claim the market has broken in an echo of the EU’s claims that the gas market there no longer serves its purpose.
The degree of oil price volatility has changed but the sources of this volatility have not. As always, it’s about fundamentals, the economy, and geopolitics.
Fundamentals served traders a surprise last year as economies began to reopen after the pandemic lockdowns. Demand for oil, which BP had stated peaked in 2019, surges so fast and so much everyone got surprised by higher prices.
Meanwhile, over time, the supply risks began to emerge like rather nasty rocks from retreating water. The oil industry as a whole had been reducing its investments in big new production additions in anticipation of the energy transition to renewable power. The results of this underinvestment, as OPEC officials have called it, was bound to manifest itself sooner or later. It did, in the form of even higher prices and heightened price volatility.
Then there was central bank policy in the face of looming inflation, in big part resulting from higher energy prices. The Fed, the ECB and others decided to go all in on the tightening and interest rates flew higher in evidence that fighting fire with fire is a dangerous game.
For those who follow oil price news, the image of a seesaw would be fitting …
Oil falls one day because of concerns about the economy as central banks try to fight inflation with higher rates in the United States in Europe, and as China’s government pours billions into industry to stimulate growth, which goes with oil demand.
Then, oil falls on the next day because an OPEC official suggests that the cartel might reverse production growth plans and opt for cuts instead. Or, a G7 leader says the discussions of a price cap on Russian oil are progressing.
Indeed, G7 finance ministers agreed today to implement a broad price cap on Russian oil, even though Russia already made it clear it would not take it lying down. In fact, Deputy PM Alexander Novak said it directly yesterday.
“This is completely ridiculous,” Novak said, as quoted by Kommersant. “We will simply stop supplying crude and fuels to countries that introduce a price cap because we will not work in non-market conditions.”
This is geopolitics territory now. Sanctioning the world’s largest exporter of crude oil and oil products may have seemed a good idea to signal what can only be described as ‘virtue’ at the time, but it has since become clear Russia isn’t just surviving–it’s not suffering losses and is both producing as much oil than before the war in the Ukraine began and bringing in more revenues for its war coffers.
Meanwhile, politics is a big reason why U.S. shale drillers are going about production growth a lot more slowly and cautiously than they normally do, contributing to oil price volatility.
With the Biden administration unwavering in its support for the energy transition, the industry has seen it as less risky to avoid rushing into production growth just because Washington begs it to do so.
Incidentally, the U.S. is not the only government supporting fossil fuels despite climate change pledges. In fact, a study by the IEA and the OECD found that government support for oil and gas rose almost twofold last year. This means support for fossil fuels from governments seemingly dedicated to a transition to low-carbon energy. If these are not mixed signals, it would be interesting to see what are.
The extreme swings in prices, then, have a perfectly rational background. The price of oil can swing on a single news report quoting anonymous sources. It would just swing harder now because of the excessive sensitivity of traders with so much going on around oil.
The good news for those traders who, unlike most in that field, dislike volatility, is that extreme volatility does not last, just like extreme weather. It will take a while until that faceless market made up of thousands of people like Pierre Andurand calms down. The wild swings could become the new normal or they could even out over time.
It’s really an either-or situation, a zero-sum game. Central banks’ rate war on inflation will either work or it won’t. Price caps on Russia will either be imposed, which would result in yet another jump in prices, or quietly shelved, which would stabilize prices. That is, until OPEC decides to cut, which could happen as early as next Monday.
By Irina Slav for Oilprice.com
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