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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. 

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Oil Risk Premium Wanes

  • At the end of April, hedge funds and other money managers started shedding long positions in the most important petroleum contracts.
  • With the Middle East always lurking in the background, the market is now looking at the other two major drivers of oil prices – what OPEC+ would do next and what the Fed would do next.
  • The easing of tensions between Israel and Iran is one of the reasons that the geopolitical risk premium in crude is shrinking.
Mid East

Oil prices slumped by $10 per barrel in a month, from above $90 Brent in early April to the low $80s, as tensions in the Middle East subsided and prompted money managers to shift their focus on the upcoming OPEC+ decisions and the path to lower interest rates.

In early April, the Iran-Israel standoff and the rising tensions in the most important region for oil supply led to a spike in prices to over $90 per barrel amid higher risk premium in the market. A month later, fears of escalation and potential disruption to oil supply have faded, and so has the war premium in crude oil prices.     

War Premium Declines

At the end of April, hedge funds and other money managers started shedding long positions in the most important petroleum contracts after Israel and Iran chose not to escalate the standoff in early April.  

To compare, earlier last month, traders were flocking to the crude oil options market, trading record numbers of call options that Brent would hit $100 per barrel in the coming months.

In Brent Crude, call options at $100 and $110 per barrel have been the most popular options held by traders over the next 12 months, data from ICE Futures Europe compiled by Bloomberg showed in mid-April.

Many investment banks raised their short-term oil price forecasts, with some even expecting $100 oil this summer.

However, prices couldn’t hit too far above $90 per barrel, as rising U.S. commercial stocks and views of ‘higher for longer’ inflation and interest rates capped price gains. The market and analysts were acutely aware of the fact that oil prices could hit the triple digits only if there is a direct threat to oil supply from the Middle East. And even in that case, speculators were betting that around 5 million barrels per day (bpd) of OPEC’s current spare capacity reduced concerns about a significant disruption to supply from Iran if the U.S. chose to try to clamp down on Iranian crude exports. Related: Can Utica Shale Really Compete With the Permian?

The biggest concern about Middle Eastern oil supply has always been Iran attempting to block tanker traffic in the Strait of Hormuz, the most important oil trade chokepoint. About 21 million barrels per day (bpd), or a fifth of the world’s daily consumption, is being transported out of the top Middle Eastern exporters via the Strait of Hormuz.    

There hasn’t even been a hint of such attempts, and analysts believe that Iran would shoot itself in the foot if it tried a blockade because its oil exports – mostly going to China – also pass through that chokepoint.

The Move Lower

Amid eased tensions in the Middle East – for now – traders and speculators sold petroleum futures and options in the week to April 23 at the fastest pace since October 2023, per market data cited by Reuters columnist John Kemp.

In the following week to April 30, the correction in crude oil prices continued, with positioning in the U.S. benchmark WTI Crude driven by new short positions and buying in Brent supported by fresh longs entering at lower levels, Ole Hansen, Head of Commodity Strategy at Saxo Bank, wrote on Monday in an analysis of the commitment of traders in the latest reporting week.

“On geopolitics, the probability implied from the options market of Brent above $100 by year end has reset back to 9% from reaching as high as 17%,” Tanvir Sandhu, Bloomberg Intelligence’s Chief Global Derivatives Strategist, says.

“The price action around tensions in the Middle East is often short-lived without any signs that it’s impacting oil supply. There is a fair bit of dispersion and volatility in the commodity space which creates trading opportunities,” Sandhu added. 

Next Market Catalysts

With the Middle East always lurking in the background, the market is now looking at the other two major drivers of oil prices – what OPEC+ would do next and what the Fed would do next.  

The Middle East shouldn’t be discarded as a price factor, analysts say.

“The risk premium in the oil market continues to erode as geopolitical tension in the Middle East eases. However, this is a factor that could return to the market, so is not something that should be fully discounted,” ING strategists Warren Patterson and Ewa Manthey wrote in a note at the end of last week.

Meanwhile, analysts are looking at the upcoming meetings in June of the OPEC+ group and the Fed for clues about global oil supply and demand, respectively.

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Most traders surveyed by Bloomberg last week expect OPEC+ to extend the production cuts into the second half of the year, especially if oil prices don’t rebound to close to $90 a barrel again before June 1.  

Then, the Fed meeting on June 12 is widely expected to leave interest rates as-is. According to the CME FedWatch Tool, only 8.7% of interest rate traders expect the central bank to lower the key interest rates at next month’s meeting.

Higher for longer interest rates could negatively impact oil demand growth.

In recent days, the market has returned to focus on factors that can affect fundamentals at the expense of tensions in the Middle East. However, considering the knee-jerk reaction of traders to geopolitical events, spikes, and corrections are sure to follow throughout the summer and beyond.

By Tsvetana Paraskova for Oilprice.com

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