The end of September saw some notable developments in the oil patch, particularly regarding news out of an “informal” OPEC meeting in Algiers, Algeria.
The Organization of the Petroleum Exporting Countries (OPEC) lost some relevance in the last decade when the price of a crude oil skyrocketed above $100/barrel. The cartel had collaborated over the years in order to keep the price above levels they deemed appropriate. With oil in the stratosphere, there was little for the group to do except count the profits.
Interestingly, the changing geopolitical landscape in the Middle East also disrupted some of the long-time alliances in the group. The combination of these factors made it more difficult for OPEC to agree on a common policy when oil prices plummeted.
It’s the above context that makes news out of Algiers that the group has agreed on a new production cut such an eye-catching headline.
Details at this point have not been confirmed, but it's widely believed that a cut of about 700,000 barrels of daily supply is expected to be announced in November (and instituted in 2017). More important than the actual number may be the fact that the group has overcome internal politics and could be once again tightening their grip on control over one of the world’s most important commodities.
Oil prices have been a leader in the market since they first started their precipitous decline in 2014. It was only when crude bounced in early 2016 that global equities also recovered (and since took flight).
Now that the framework of a deal is in place, it’s possible that volatility in oil prices could decline in the near-to-medium term. However, that thesis is founded on OPEC taking the deal from agreement to execution without any unexpected snags.
For those traders with exposure to the energy sector, a past installment of Market Measures focusing on crude oil volatility may be worth reviewing - especially given current developments.
On the episode, the Market Measures team presents data related to the OVX (the CBOE Crude Oil Volatility Index). Charted alongside the price of crude oil (as shown below), one can see a clear inverse correlation between the two metrics:
Further probing this topic, the team reviewed data from 2007 to present which shows the OVX has tended over that timeframe to decrease more than it increases, on average, per year. The graphic illustrating this behavior is embedded within the episode.
OPEC in recent years has tried and failed to produce a credible agreement on limiting production across their membership. While a deal now looks like it could be instituted, their are still hurdles that could derail the process.
On the other hand, OPEC has arguably moved further along in the negotiating process than any time in recent history. And if they do put the agreement in place, and the participating nations hold firm to their allotted production quotas, it’s possible this may represent yet another regime shift in the history of oil trading.
Adding to the OVX to your watch list and following the behavior of crude oil-related volatility would no doubt be beneficial over the coming months to best understand the impact of OPEC’s actions on the market. It’s possible that an opportunity may present itself in the energy sector that fits your strategic approach and risk profile.
If you have any questions about energy volatility we hope you leave a comment below or reach out 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.