March 21, 2017    3 minute read

The Global Oil Market: Towards Persistent yet Small-scale Volatility?

It Takes Two to Contango    March 21, 2017    3 minute read

The Global Oil Market: Towards Persistent yet Small-scale Volatility?

Last week, oil prices fell by 10% as news regarding stronger-than-expected North American production echoed across international markets. This news added to the recent uptick in the oil market’s price volatility.

Between September 2016 and January 2017, the international oil market experienced a brief period of reduced volatility. Expectations of output cuts by OPEC countries (and Russia) led to reduced expected supply of crude.

A future outlook of higher prices coupled with relatively higher demand (as the world economy recovers from a period of sluggish growth) pushed the price of crude above $50 per barrel and flattened the market’s contango structure. Contango refers to a situation where the future price sits above the expected future spot price. The opposite market structure is backwardation, where the future price sits below the expected future spot price. In the first case, futures’ prices are recording a downward trend over time, while in the second, futures’ prices are increasing over time.

A Momentary Lapse

However, that proved to be a short-lived equilibrium. Increasing doubts to whether or not OPEC will be able to sufficiently curb world output, given higher than expected US-based production, motivated an upward revision of future output expectations.

The rise of the US as the world’s top oil producing country, according to estimates of existing fields and future discoveries, coupled with the country’s positioning as the greatest oil consumer and the sector’s output transparency (in terms of data), lends it an outsized influence over the market. This is showcased by the ripple effects caused on the world oil market by the US Information Administration’s upward revision of output expectations for the near future – an increase of 300,000 barrels per day (B/D) for 2017 (reaching a total of 9.2 million B/D), followed by a further increase of 500,000 B/D in 2018.

That is not to say that the US has become the producer of the marginal barrel of oil. The country’s sector does not have the capacity to set the price of crude by determining world supply given current demand – as Saudi Arabia used to do in the period following the demise of the Seven Sisters cartel which dominated the mid-20th century petroleum market.

Who Leads the Oil Market?

Although, by assuming a leading role in determining the upper cap of the price of crude, the US limits OPEC’s price-setting capacity to just determining the lower cap (through OPEC’s capacity to flood the market).

This outcome is the result of the recent price wars between the US shale producers and OPEC. Consolidation in the US shale industry has led to significant efficiency gains, resulting in a current output level that is less responsive to price changes. This divorces the commodity from OPEC’s monopolistic control, introducing a new normal of heightened price volatility.

However, such extreme uncertainty as the oil price surging up to $100 per barrel and then plummeting back down to $50 per barrel is not in the cards for the near future. Saudi Arabia appears determined enough to protect the OPEC agreement, if not extend it, in anticipation of Aramco’s initial public offering.

Moreover, demand for oil is not to peak before some time between the mid-2020s and the late 2030s, according to estimates from Royal Dutch and Statoil (the International Energy Agency, meanwhile, forecasts peak oil demand in the 2040s). This suggests that the international oil market is moving towards a less constricted structure of supply determination, resulting in small-scale price volatility rather than wild swings.


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