- Hedge funds are pulling out of oil as price volatility becomes excessive.
- Oil trading activity has fallen to the lowest level in seven years.
- The volatility is even impacting other industries as businesses which normally use oil hedges to secure price stability shy away from the practice.
Price volatility is a trader’s bread and butter, but in oil, volatility is becoming excessive, pushing traders away and making life harder for a lot of businesses that normally use oil hedges to secure some price stability that is vital for their operations. This is according to a Reuters analysis that notes oil prices have become so wild in their everyday swings that the usual suspects, such s hedge funds, are quitting the oil market in droves, with activity there falling to the lowest in seven years.
It appears, then, that volatility is only a good thing up to a point, and this point seems to be a daily price range five times the usual one. According to the Reuters analysis, between February 24 and August 15 this year, Brent crude’s daily range averaged $5.64 per barrel. This compared with $1.99 per barrel last year.
The pullout of the speculators is only one of the problems with such high oil price volatility. The fact that companies in the food industry, for example, don’t dare hedge against further price swings is affecting their business. And it is also affecting the business of the oil industry itself.
One analyst cited by Reuters explained that oil companies are being wary of capital expenditure because of the excessive volatility in oil markets. And because they are being wary, these companies are delaying projects that could help bring the oil market into balance again, Arjun Murti told Reuters.
Speaking of the oil industry, it is not only the current volatility that is interfering with potential production growth. It is also the uncertainty about future demand as the transition movement gathers pace.
In a recent piece for the Houston Chronicle, James Osborne wrote that predicting oil demand was becoming increasingly difficult amid developments such as the now notorious Inflation Reduction Act that Congress passed earlier this month.
With all these incentives for the electrification of transport and the shift to renewable electricity generation, the future of oil demand has dimmed, he argued, even according to Big Oil.
One might argue that most Big Oil is heavily involving itself in the energy transition, which might cast a shadow over the credibility of its oil demand predictions. Yet the fact remains many governments are dead set on having a transition, however much it costs, and that’s bearish for oil demand.
The latest transition push in both Europe and the U.S. probably made a bad volatility situation worse by clouding the demand outlook while everyone can see with a plain eye that oil demand, right now, is stronger than many had expected, especially as some utilities in Europe switch from gas to oil due to prices.
This has proved too much not only for speculators but also for industry players in the oil market, according to the Reuters analysis. Open interest on the oil futures market has dropped by a fifth since Russia invaded Ukraine, with traders apparently getting tired of the price seesaw of tight supply and inflation fears.
What the future holds is—as always—impossible to say, but it is quite unlikely that the price situation will change anytime soon. This means that the negative effect this price volatility is having on businesses across industries will continue, fueling the abovementioned oil price seesaw.
Businesses will continue to need energy that is in tight supply, but high prices for this energy will continue threatening their growth prospects and the growth prospects of their respective economies. Governments, meanwhile, will continue pouring money and legislation into the energy transition, further discouraging the oil industry from doing something meaningful about supply.
By Irina Slav for Oilprice.com
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Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.
Published at Sun, 21 Aug 2022 16:00:00 -0700