Is the oil market really broken?

“Oil futures market is totally devastated. $10 a day cut for no apparent reason,” chirp Famous hedge fund Pierre Andorand this week. In fact, volatility these days is not what it was just a couple of years ago. However, it may be a bit of an exaggeration to claim that the market has broken into echoing EU claims that the gas market there is no longer serving its purpose.

The degree of volatility of oil prices has changed, but the sources of this volatility have not. As always, it’s all about basics, economics, and geopolitics.

Fundamentals provided a surprise to traders last year as economies began to reopen after the pandemic shutdowns. The demand for oil, which BP said peaked in 2019, rose very quickly and everyone was surprised by the price hike.

Meanwhile, over time, supply hazards began to appear like rather poor boulders from receding water. The oil industry as a whole has been reducing its investment in large new production additions in anticipation of the energy transition to renewables. The results of this underinvestment, as OPEC officials called it, were bound to manifest themselves sooner or later. He did, in the form of higher prices and increased price swings.

Then there was the central bank’s policy in the face of looming inflation, caused in large part by rising energy prices. The Fed, the European Central Bank and others decided to push ahead with the tightening process and interest rates flew higher in evidence that fighting fire with fire is a dangerous game.

For those who follow the news of oil prices, a trapeze picture will be appropriate …

Oil is falling one day due to concerns about the economy as central banks try to fight inflation at higher rates in the US in Europe, and with the Chinese government pumping billions into the industry to stimulate growth in line with oil demand.

Related: European Commission calls for capping Russian natural gas prices

After that, oil falls the next day because an OPEC official indicates that the organization may reverse production growth plans and opt for cuts instead. Or, the G7 leader says discussions about capping Russian oil prices are advancing.

Indeed, the finance ministers of the Group of Seven major industrialized countries agreed today to implement a cap on Russian oil prices, although Russia has already made it clear that it will not eliminate it. In fact, Deputy Prime Minister Alexander Novak said it directly yesterday.

“This is absolutely ridiculous,” Novak said. quoted by Kommersant. “We will simply stop supplying crude oil and fuel to countries that apply price caps because we will not operate in non-market conditions.”

This is a geopolitical area now. Punishing the world’s largest exporter of crude oil and petroleum products may have seemed a good idea to point to what could only be described as “virtue” at the time, but it has since become clear that not only is Russia surviving – it’s not suffering losses and both. Producer More oil than before the outbreak of the war in Ukraine and bring more revenue to the war coffers.

Meanwhile, politics is a big reason why US shale drilling companies are increasing production more slowly and cautiously than they usually do, contributing to oil price volatility.

Because the Biden administration is unwavering in its support of the energy transition, the industry has seen it less risky to avoid a rush to production growth simply because Washington tells it to do so.

Incidentally, the US isn’t the only government that subsidizes fossil fuels despite climate change pledges. In fact, a study by the International Energy Agency and the Organization for Economic Co-operation and Development found that government subsidies for oil and gas nearly doubled last year. This means governments subsidizing fossil fuels that seem dedicated to the transition to low-carbon energy. If these aren’t mixed signals, it would be interesting to see what they are.

Thus, extreme price fluctuations have a quite logical background. Oil price can fluctuate in one news report citing anonymous sources. It will swing a lot more difficult now due to the hypersensitivity of traders with a lot of trading around oil.

The good news for those traders who, unlike most traders in the field, don’t like volatility, is that extreme volatility doesn’t last, just like extreme weather. It will take some time for this anonymous market of thousands like Pierre Andorand to calm down. Wild fluctuations can become the new normal or may fade over time.

It’s really either a situation or a zero-sum game. The interest-rate war waged by central banks on inflation will either work or not. Price caps will be imposed on Russia, which could lead to another price jump, or they will be quietly suspended, stabilizing prices. That is, until OPEC decides to cut, which could happen as early as next Monday.

By Irina Slough for Oilprice.com

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