Oil Prices are Highly Volatile But Essentially Stuck in a Rut

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Source: Adobe Stock/kropman.

Traders love volatility.

They say that today’s electronic trading platforms play to that desire of investors to make a buck, regardless of the fundamentals, allowing investors to play each twitch up and each slip down at the touch of a button.

Oil Prices: Perception vs. Reality

Indeed, if you can shape the perception of those fundamentals so much the better, and that seems to be what has been happening in the oil market this year. In reality, the world is as awash with oil today just as it was six months ago. As it dawns on the market that nothing much has changed, prices fall and producers make statements like a cutback deal is near, or an output freeze is being discussed — bingo! up goes the market by several dollars a barrel and you can bet producers and investors alike are rubbing their hands in glee.

Then, news comes out reminding us of the reality of the situation: the Environmental Protection Agency reports that gasoline stocks are up 600,000 barrels and distillates like diesel up 4.6 million barrels. The news that refiners are drawing on crude reserves only to process it into unwanted downstream products depresses the markets and prices fall again.

But that’s fine if you are a trader. You knew that talk of an output freeze lacked credibility and, having made your money on the way up, you got out, probably shorted the market waiting for reality to sink in and were positioned for a softening of prices.

The long term fundamentals are getting stronger for oil with every passing month, new discoveries adding to oil reserves are running at their lowest level for 60 years as capital expenditure has collapsed. The International Energy Agency says the amount that the world’s oil companies are spending on drilling projects has fallen from $780 billion to $450 billion, and is still falling. Worse, much of it has fallen in higher cost western locations making us more reliant on politically less stable regions like the Middle East and Russia. But, long-term fundamentals are not what drives day to day or even month to month oil prices and the costs consumers are incurring either directly as fuel or in costs indexed to the oil price.

Conflicting Demands

For every article calling out a return to $65/barrel prices, there is another calling out a fall below $40. The most probable path over the next six months is more of the same: volatility between the low $40s and the high $50s. Producers will talk up the market when it drops toward the $40 benchmark and reports of an oil glut or an uptick in shale drilling rig counts will prick the bubble if prices approach $60. Meanwhile slow global growth is at least being supported by relatively benign, if volatile in percentage terms, oil prices.

What happens later this decade is another matter, but an issue only long-term strategic planners need to worry about today.

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