When volatility picks up in one niche of the financial markets, it usually spreads to some of the others. In the modern world economy, there's simply too many interlinked (Blade Runner 2049 shout-out for the Sci-Fi enthusiasts) parts for contagions to remain isolated.
In that sense, recent volatility in the global equity markets certainly has contributed to increased volatility in crude oil trading, at least to some degree.
As many probably recall, oil markets were already on edge last year when the Trump administration started coordinating an international boycott of Iranian oil exports.
The boycott came about after President Donald Trump abruptly withdrew the United States from the Iran Nuclear Agreement, and was planning to punish Iran (by limiting the country's income from oil) until they complied with the United States’ demands relating to Iran's nuclear ambitions. At that time, energy analysts predicted that between 1 million and 2 million barrels of oil could come offline when allies of the United States stopped buying crude from Iran.
Given how closely aligned global oil production and demand have been in recent years, many expected that a comprehensive (and successful) international boycott would leave the oil market severely under-supplied, and in turn cause a spike in the underlying price.
Looking at a historical price chart, one can see how the value of crude oil increased steadily as the start of the expected boycott grew closer. In the final weeks leading up to the November deadline, the Trump administration even asked some of the world's largest oil producers (i.e. Russia and Saudi Arabia) to increase their daily production in order to offset the expected void left by Iran.
Given that set of expectations, it's no wonder prices fell off a cliff in the wake of the event (or better described "non-event’). Instead of strictly enforcing the Iranian oil boycott, as the Trump administration had indicated prior to November, last minute "exceptions" were granted to a variety of countries which effectively kept Iranian oil on the market.
The net result was that a market which was expected to be extremely tight was instead over-supplied, and prices decreased rapidly to account for the new market dynamic.
Another factor that contributed to the intensity of the slide, was the trade war, which is ongoing. Escalation of the trade war forced many economists to lower their growth forecasts for the global economy. Because crude oil demand usually hinges on the direction of the worldwide economy, that means the demand side of the crude oil equation has also been under pressure.
Taken together, that means the primary themes in the oil market have been declining demand and rising supply - the perfect storm for a crash in prices.
Referring back to the historical price chart in crude oil, one can see how prices peaked last fall leading up to the Iran deal - oil notched multi-year highs at around $75/barrel. Then, when the severity of the boycott was softened, the market found itself over-supplied, and crude prices dipped roughly 40% (to the low $40s/barrel) in just a few months.
With prices reeling, the world's energy cartel (OPEC) convened in order to negotiate another production cut. After raising production to accommodate the United States in the fall, OPEC reversed course in December and instituted another coordinated supply cut - with the hope of boosting prices.
The early returns suggest that OPEC has been successful in achieving its goal. Since the production cut was announced on December 7th, 2018, oil has rallied about 24% in only a month’s time. However, oil prices are still down about 31% from their peak last year.
If you want to learn more about expectations for crude oil in 2019, a new episode of Futures Measures is definitely worth a few moments of your time. On the show, the hosts outline analysts expectations for the price of crude in the new year, and also compare the historical performance of several different trading structures in the oil patch.
One qualitative story to follow in 2019 is whether or not the “exceptions” that were granted relating to the Iranian oil boycott will be terminated at some point. If that were to occur, especially while OPEC is throttling production, then another rapid price increase could materialize.
Traders looking to expand their oil trading repertoire may also want to review a previous installment of Futures Measures entitled "Guide to Trading Crude Oil." This show explores some more advanced position structures in oil futures.
Another great way to follow the oil narrative in 2019 is to track the OVX, which operates much like the VIX does for the S&P 500 - serving as a gauge for implied volatility. The OVX had been trading in high 20s and low 30s for much of 2018, before breaking out above 60 when oil prices fell of a cliff last fall. As of the first week of January 2019, the OVX has moderated slightly to around 46.
If you have any outstanding questions about the energy market, we hope you'll reach out by leaving a message in the space below, or emailing us at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.