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Oil Market Volatility Surges

Friday May 24, 2019

1. Offshore spending on the rise

Offshore

(Click to enlarge)

- Offshore investment is surging once again, although the uptick may only prove to be temporary.

- The services market for offshore drilling will slow from 7 percent annual growth per year in 2019-2022 to just 3 percent from 2022-2025, according to Rystad Energy.

- Higher prices has sparked more investment, but the resulting supply increase could push prices back down, cratering investment all over again. Roughly 5 million barrels of oil equivalent per day (boe/d) from the latest round of investment will begin production from 2022.

- Offshore projects, unlike short-cycle shale, depend on price stability. “Just how things ultimately play out in the offshore market will depend to a large extent on whether OPEC, with help from Russia, will decide to take serious measures to stabilize the market over the next years,” Audun Martinsen, Head of Oilfield Service Research at Rystad Energy, said in a statement. “If the group decides to rein in production to protect commodity prices, momentum in the offshore market could continue. If not, the offshore renaissance party seems destined to come to an end in 2022.”

2. Palladium still undersupplied

Palladium

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- Palladium prices have surged in recent years, a material used in automobile technologies to control emissions. The rise of electric vehicles and other pollution control technologies has driven up demand for palladium.

- Higher prices have spurred talk of switching to platinum. “Replacing palladium with platinum has been a hot topic since palladium prices started closing in on platinum in 2017, but substitution has been muted to date,” Standard Chartered wrote in a note.

- Swapping platinum for palladium is more feasible for diesel vehicles, but that market has been shrinking. Automakers are on the hunt for alternatives, but it could take time.

- “It is also worth noting that tighter emissions standards in China are set to boost both palladium and rhodium loadings,” Standard Chartered said. “Thus, even if substitution does materialise, the palladium market is set to remain in deficit over the next two to three years and platinum is likely to edge towards a balanced market.”

3. Rising oil volatility

Volatility

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- Oil volatility spiked this week as trade fears led to a sharp selloff on Thursday.

- For much of this year, volatility had remained subdued, despite the glaring geopolitical risks and supply outages in Iran, Venezuela and potentially in Libya.

- “[P]artly because global oil inventories are balanced, oil options markets are ignoring these risks,” Bank of America Merrill Lynch wrote in a recent report. Oil markets are “underpricing Iran risks,” the bank said.

- A series of analysts see volatility on the rise. “The geopolitical risk environment is dangerously close to the levels we haven’t seen since the early stages of Operation Iraqi Freedom” in 2003, warned Robbie Fraser, a senior commodity analyst at Schneider Electric.

- The Oxford Institute for Energy Studies (OIES) agreed in a new report, saying: “The extent of dislocations in expectations and the challenge of navigating in the current foggy conditions indicate that the oil market is set for a very bumpy ride.”

- However, the downside risk of the U.S.-China trade war is winning out. Markets sank on Thursday. The only thing that did well was the CBOE Volatility Index, which surged 15 percent.

4. Dollar drags down gold

Gold

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- Dollar strength continues to anchor gold. The U.S.-China trade war has strengthened the dollar and pushed down the Chinese yuan. “A weaker CNY makes gold in Chinese currency more expensive, thereby weighing on gold demand there,” Commerzbank wrote in a note.

- China is the world’s largest consumer of gold.

- But there is a bit of a floor in gold right now, with buyers jumping in when prices drop. Gold ETFs saw inflows of 4.1 tons last Friday when prices slid, Commerzbank pointed out.

- Meanwhile, as global equities run into trouble, gold acts as a safehaven. With equities in a sea of red on Thursday, gold actually ticked up by 0.75 percent to $1,284 per troy ounce.

5. Renewable energy cheaper than coal

Renewables

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- Coal-fired power plants continue to shutter in the U.S., despite a friendly administration in Washington.

- Renewable energy is cheaper than coal by a wide and growing margin. According to Lazard, the levelized cost of electricity, on an unsubsidized basis, for solar power has fallen as low as $43/megawatt-hour. For coal, it is more than twice as high at $102/megawatt-hour.

- Wind edges out solar at $42/megawatt-hour.

- Indeed, renewables are increasingly the cheapest form of electricity generation, even outcompeting existing coal-fired power plants.

6. Treasury yields drop to two-year low

Treasury

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- Yields on 10-year U.S. Treasuries fell to their lowest level since 2017 this week, dragged down by the global equity selloff. Treasury yields fell to 2.32 percent.

- Capital flocked into safehavens, fleeing riskier assets.

- Bonds in Europe also rose, pushing yields down.

- Investors are now pricing in greater odds that the Federal Reserve cuts interest rates again, reversing course from the rate increases last year.

- To the extent that crude oil and other commodities continue to slide, they will suppress inflation, further bolstering the case for rate cuts.

7. Trade war slams U.S. farm country

Soybeans

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- President Trump announced $16 billion in additional aid to U.S. farmers, helping them mitigate some of the losses from the trade war. The aid comes after $12 billion in funding last year.

- In effect, U.S. consumers are paying twice for the trade war – once via higher tariffs on imports, and a second time through taxpayer aid to American farmers.

- But, the U.S. agricultural sector is indeed in crisis. In February, U.S. soybean exports to China dropped to $2.35 billion, down from $11.2 billion last June when the first round of tariffs was announced, according to the Wall Street Journal.

- The Trump administration is considering another round of tariffs on $350 billion worth of Chinese goods, although those levies are likely a few months away and would only come after the expected Trump-Xi meeting in June.



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