The degree of oil price volatility has changed, but the sources of that volatility have not. As always, it’s about fundamentals, economics and geopolitics. Fundamentals served traders a surprise last year as economies began to reopen after the pandemic lockdown. Demand for oil, which BP had said peaked in 2019, is growing so fast that everyone was surprised by the higher prices. Meanwhile, over time, supply risks began to emerge like rather ugly rocks from the receding water. The oil industry as a whole has been reducing investment in major new production additions in anticipation of the energy transition to renewable energy. The effects of this underinvestment, as OPEC officials call it, were bound to show up sooner or later. It did, in the form of even higher prices and increased price volatility. Then there was the central bank’s policy towards looming inflation, largely driven by higher energy prices. The Fed, ECB and others decided to join the tightening and interest rates rose, proving that fighting fire with fire is a dangerous game. For those following the news on oil prices, the image of a seesaw would fit… Oil fell for a day on worries about the economy as central banks try to fight higher inflation in the United States and Europe and as China’s government pours billions into industry to boost growth, which is matched by demand oil. Oil then falls the next day because an OPEC official suggests the cartel may reverse plans to increase output and opt for cuts instead. Or, a G7 leader says talks on a price cap on Russian oil are moving forward. Indeed, G7 finance ministers agreed today to implement a broad price ceiling for Russian oil, even though Russia has already made it clear it won’t take it lying down. In fact, the Deputy Prime Minister Alexander Novak said it directly yesterday. “This is completely ridiculous,” Novak said, according to Kommersant. “We will simply stop supplying crude oil and fuel to countries that introduce a price cap because we will not work in non-market conditions.” This is geopolitical territory now. Sanctioning the world’s largest exporter of crude oil and petroleum products may have seemed like a good idea to signal what can only be described as “virtue” at the time, but it has since become clear that Russia isn’t just surviving – it’s suffering losses and it produces as much oil as it did before the war in Ukraine started and brings in more revenue for its war coffers. Meanwhile, politics is a big reason why U.S. shale drillers are ramping up output much more slowly and cautiously than usual, contributing to oil price volatility. With the Biden administration staunchly supporting the energy transition, the industry sees it as less risky to avoid rushing production just because Washington is begging it to. By the way, the US is not the only government to support fossil fuels despite climate change commitments. Indeed, a study by the ILO and the OECD found that government support for oil and gas almost doubled last year. This means support for fossil fuels from governments ostensibly committed to the transition to low-carbon energy. If these are not mixed signals, it would be interesting to see what is. The extreme price fluctuations, therefore, have a perfectly rational background. The price of oil can swing on a single report citing anonymous sources. It would just be more difficult now because of the over-sensitivity of traders with so much going on around oil. The good news for those traders who, unlike most in this field, dislike volatility, is that extreme volatility does not last, just like extreme weather. It will take some time for this faceless market of thousands of people like Pierre Andurand to calm down. Wild swings could become the new normal, or they could die out over time. It’s really an either-or situation, a zero-sum game. The central banks’ interest rate war against inflation will either work or not. The price caps in Russia will either be imposed, which would result in another jump in prices, or remain silent, which would stabilize prices. That is, until OPEC decides to make cuts, which could happen as early as next Monday. By Irina Slav for Oilprice.com More top reads from Oilprice.com:
