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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Oil Price Volatility Crashes To Three-Year Low

Oil prices have jumped to multi-year highs at the same time that price volatility continues to plunge.

Oil price volatility continues to dive, dropping to a three-year low as 2017 comes to a close. The CBOE Crude Oil Volatility Index (OVX) recently dipped below 20, a level not seen since the third quarter of 2014.

(Click to enlarge)

CBOE Crude Volatility Index at a 3-year low

Oil prices have been on a wild ride since the market downturn began in the middle of 2014, with several serious meltdowns followed by price rallies that often turned out to be fleeting. The twists and turns left oil traders fumbling for some direction, and the prevailing uncertainty caused the oil price volatility index to surge to highs not seen since the 2008-2009 financial crisis.

However, since OPEC and its non-OPEC partners agreed to limit production a little more than a year ago, the OVX index fell dramatically, which is to say, oil price volatility dropped to levels not seen in several years. It wasn’t uncommon in 2015 or 2016 to see daily price changes on the order of 5 percent – but that kind of drama all but disappeared in 2017.

The extension of the OPEC deal a few weeks ago took another bite out of volatility, adding a degree of certainty to the direction of oil prices for the next year. OVX dropped to three-year lows in December. That isn’t to say there is a great deal of certainty in what happens next – there isn’t – but only that oil traders are not as fidgety about the day-to-day as they used to be. Related: Permian Beats Own Record In Oil Production

Some analysts think that low volatility will stretch into next year as OPEC continues to provide a backstop. “OPEC’s decision to proactively manage the market is going to keep volatility flat as a pancake,” Amrita Sen, chief oil market analyst at Energy Aspects Ltd., wrote in a December research note.

Still, it does seem odd that everyone feels so comfortable with such low volatility, especially because, there is a long list of potential surprises that could upset the balance. In December alone, there were a series of surprises that cropped up – unexpected outages from the crack in the Forties pipeline, an explosion at a pipeline in Libya, and a workers strikes in Nigeria. More serious black swans loom in 2018 – sharp production declines in Venezuela, more instability in Libya or Nigeria and a potential conflict between the U.S. and Iran. On the downside, higher-than-expected shale output, a deterioration of OPEC compliance, or an economic downturn that hits demand could also upset oil price stability.

Then, there are issues with the futures market. At the start of 2018, hedge funds and other money managers have amassed an astounding number of bullish bets on the direction of oil, and the positioning looks lopsided. In several previous price cycles, when the bets become this one-sided, it tends to precipitate a selloff. Related: Chinese Ships Caught Illegally Selling Oil To North Korea

Interestingly, oil prices are not the only thing to see a surprisingly subdued level of trading. The CBOE Volatility Index (VIX), which measures volatility in the stock market, is also at a three-decade low, and is down 10 percent from the second lowest year in that timeframe. Bloomberg noted, using an analysis from ETF.com, that seven of the 20 worst-performing ETFs in 2017 had bet on higher volatility by going long on the VIX index, getting burned by the lack of significant price swings. Now, investors are still shorting the index, betting that volatility will fall further still as we head into 2018.

At the same time, just because the stock market was stable in 2017 does not mean that 2018 will be a rerun. Bloomberg noted that in a survey of 229 investors representing $6 trillion in assets, conducted by Absolute Strategy Research, about three-quarters of respondents said that the low levels of volatility are “unsustainable.” The global economy could provide some sparks to a rebound in volatility – rate tightening from the Fed, some cracks in the global economy, or an overvalued stock market.

Any of those issues would have knock on effects in the oil market. And with oil price volatility at such low levels, it wouldn’t take much to kick start a new round of rockier trading.

By Nick Cunningham of Oilprice.com

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