The last few weeks have been an interesting time for oil. On March 09. 2017, we hosted a customer for a Five Star Lunch and Learn presentation. As part of our presentation for each luncheon, we give a market analysis for where we see oil prices headed.
During that presentation, I spoke about the lack of volatility, since the beginning of the year, in oil prices. If you took a snap shot of WTI and Brent on from the beginning of the year until March 08, 2017, you would have seen a very stable commodity price. In fact, what you would have noticed is that front-month prices over the last month (one measure of volatility) fell to their lowest level since July 2003 – suggesting a vary narrow price range for oil. And presumptively, suggesting some consensus in the market.
This all appeared to change on March 08, 2017, when crude went into free fall, falling from $53.14 on March 7th, to $50.28. The next day, WTI broke the key psychological barrier of $50.00. And viola we have volatility back in the market!
As the above chart demonstrates, you can see lower and lower volatility. This becomes particularly apparent when one considers it in terms of how many standard deviations it is, which considers volatility from a statistical perspective of how volatile oil is an average. In that case, you would see that oil became, for a short time, a very stable commodity.
The more interesting part to me is that crunch actually appears to have started a little before that day. Indeed, it actually started on February 21, 2017, when prices, calendar spreads, and long positions all peaked. Front-month futures prices peaked at $56.66. And whereas futures prices had been trading within one standard deviation of the mean, they quickly became more volatile approaching the one standard deviation mark before dropping substantially. Net long positions also peaked, and then began dropping. While the drop was somewhat subtle, it certainly started occurring.
So what happened on March 08? Simple. The EIA released a report showing a substantial inventory build that was unanticipated. This caused a sour reaction by the market. Whereas spreads had been moving from contango to backwardation (surplus to deficit) and indicated most believed market rebalance would occur in 2H 2017 (although when that shift will happen appeared to be moving further and further out), the increase in U.S. inventories seemed to suggest that the OPEC cuts were not working as anticipated. Add to that the resurgence of shale, and the comments of the Saudi Oil Minister at CERAWeek, and markets were already on edge. In other words, it appears to be a straw that broke the camel’s back – but the back was already breaking several weeks earlier. The problem is that until we see it in historical perspective (i.e. – after February 22, 2017 where we can see the apex) the actual shift was an otherwise meaningless day.
There are many theories on what cause volatility in oil markets. The most common, and I believe the most rational, is that price changes have little to no impact on demand and supply in the short-term. If you have Suburban, you aren’t likely to sell it immediately when the price of gas goes up – but you may consider a different vehicle next time you buy a new car. Similarly, projects take some time to initiate – by the time oil prices drop, those projects are well under way. Structural barriers impede short-term changes like lack of access to capital and lack of trained personnel which means even those desiring to make quick adjustments may not be able to do so.
And of course, short term volatility is always hard to predict. On March 15, 2017, we get good news from the EIA, that stockpiles had unexpectedly decreased. On the same day, the FED announces a rate hike (a good sign that the U.S. economy is continuing to strengthen but bad for oil as it strengthens the U.S. dollar). Yet, prices stayed in a very tight range, and as of Friday March 17, 2017, continued to stay in that narrow range.
Books have been written on the subject of oil price volatility. And I’m happy to discuss it in detail with anyone who is interested. But what I find fascinating is not the volatility, but the fact that many analysts didn’t see the fundamental market shift until weeks after it occurred.
By: Ty Chapman
Five Star Metals, Inc.
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