Oil Volatility Spikes On Rampant Uncertainty

By Nick Cunningham

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The oil price rally has ground to a halt as investors pull back, Trump promises a flood of OPEC oil, and the global economy shows some signs of slowing down.

Washington’s “maximum pressure” campaign led to a spike in oil prices only a week ago, but prices crashed on Friday after Trump tweeted that he “called up OPEC” to tell them to increase production.

The seesawing means that price volatility has shot up. The 3 percent decline in oil prices on Friday was the largest single-day decline so far this year. But that came after prices increased by nearly as much at the start of the week when Trump surprised the world by deciding against extending sanctions waivers.

As the Wall Street Journal notes, oil prices made multiple daily moves of at least 2.5 percent last week, the first time that has occurred in two months. “It’s been a massive roller coaster over the last couple of months,” Tyler Ellegard, an investment analyst at Gradient Investments, told the Wall Street Journal.

Hedge funds and other money managers increased the ratio of long-to-short bets for the ninth consecutive week last week, an extraordinary demonstration of bullish sentiment. Fund managers have built up the most net long position since October 2018. At the same time, the rapid increase in long bets risks becoming overstretched, and the selloff on Friday suggests that investors are booking profits and paring back positions. The trimming of long bets can itself help spur oil price declines.

But there are also fundamental reasons why prices may have reached a temporary limit. The market is now pricing in the odds of an increase in production from OPEC+, especially after Trump tweeted that more supply was in the offing. “Gasoline prices are coming down. I called up OPEC, I said you’ve got to bring them down. You’ve got to bring them down,” Trump said.

Confusingly, multiple reports suggest that Trump did not actually speak with OPEC officials. It’s entirely plausible that there was some sort of unofficial agreement between U.S. and Saudi officials in which Saudi oil would offset outages in Iran, although it also seems more likely than not that the Trump administration and the Saudi government have different interpretations of that handshake agreement. The confusion is not helping on the price volatility front, since there is little clarity on what to expect from OPEC+ over the next few months.

“Allegedly, [Trump] spoke on the phone with Saudi Arabia and OPEC and persuaded them to permit more exports so as to lower US gasoline prices,” Commerzbank said in a note when explaining the recent plunge in oil prices. But the bank noted that most of the price declines on Friday came before Trump issued his tweet. That suggests the over-extended nature of speculative bets may be the larger culprit.

“We believe that the pronounced reaction is probably due to the situation on the futures market being currently overbought, as financial investors had recently expanded their net long positions in Brent and WTI to six-month highs,” Commerzbank wrote. “Consequently, even small levels of uncertainty can spark a more marked price response. However, because the supply situation remains tight a renewed price rise is probable.”

With the U.S. decision on Iran sanctions waivers now clear, the largest variable facing the oil market – and the one behind so much volatility – is how OPEC+ will respond. There are some within the coalition, particularly Russia, itching to put an end to the agreement. Saudi Arabia, on the other hand, is very reluctant to undercut the price rally, both because of last year’s mistake of ramping up supply too early and letting prices crash, as well as the budgetary pressures in Riyadh. The Saudi budget requires about $85 per barrel to breakeven, and while Saudi Arabia can run a deficit and raise funds by issuing new debt – likely for a long period of time – it’s safe to say that there is a desire in Riyadh for higher oil prices.

It is precisely because it’s very difficult to predict how all of these variables will come to rest that we have seen such a sudden upturn in volatility.

By Nick Cunningham of Oilprice.com

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