Oil traders face uncertain times

Vince Cable, currently the UK’s secretary of state for business, innovation and skills, once said: “When my job was attempting to predict future economic developments for the Shell oil company, I was frequently reminded of an Arabic saying: ‘Those who claim to foresee the future are lying, even if by chance they are later proved right.’” He might have been talking about the price of a barrel of crude oil – uncertainty is the only certainty, and that uncertainty is today as great as it has ever been.

To grasp just how truly savage oil price volatility can be we only need to cast our minds back to July 3, 2008, before the global financial crisis struck. Brent crude oil, the leading benchmark, traded that day at close to a record $147 a barrel – almost double that of July 2007. It was not the price that was so shocking, rather the speed at which the price had risen. Even with the global economy motoring ahead, such a rapid price rise was clearly fragile. No one could predict what would prompt a correction, how big a correction there might be – or even if a correction would happen. It was truly unknown territory and trading oil in that context was incredibly risky.

Then on July 14 President George W Bush threw one of those curve balls that can happen without warning in crude oil markets. He announced an executive decision to lift a ban on offshore oil drilling around US waters. The crude oil price immediately dropped by 8 per cent, the biggest fall since the end of the first US-Iraq war. Momentum-driven trading on futures markets carried on pushing it lower, such that within a week the price was $128, more than 11 per cent below the record (so far) $147. By the end of 2008, as the severity of the financial crash sent the developed world’s economy into a nosedive, crude oil was languishing around $30 a barrel.

Peak-to-trough collapses of around 80 per cent in a commodity price are, fortunately, rare. And crude oil prices recover as economies recover and fresh geopolitical tensions surface. Anyone who bought crude oil at $30 nearly five years ago and held their nerve – or could afford to do so – is today sitting on a paper profit of $85 a barrel. According to Chris Beauchamp, market analyst at IG: “Of course, it is easy to look back and see the opportune times to enter a trade. Holding a trade for over five years would require remarkable nerve and patience, especially given the swings in crude since then.”

Perceptions and expectations dominate the price of crude oil like no other commodity, except perhaps gold. The 2008 crude oil price crash owed nothing to actual demand collapse; by definition, demand lags behind price moves by months. The recent oil price recovery is also moving in advance of actuality, pushed by rumours (will the US intervene in Syria and what might be the regional repercussions?) and market personalities talking up (or down) their own books. Regular tiny doses of improving macroeconomic data have also helped, of course; but what drives the daily oil price volatility is often froth.

Take Syria, which is of negligible consequence for the world oil market: even before the civil war started Syria exported a meagre 150,000 barrels per day, compared to Saudi Arabia’s 10m b/d and world consumption of around 92m b/d. But any US military intervention in Syria would send huge future-uncertainty signals and have implications way beyond Syria’s actual oil export figures. As Mr Beauchamp says, “We saw a taste of this kind of volatility when Parliament voted – when the UK rejected military action the price slumped dramatically to below $105 a barrel, having been some $7 higher a few days previously.”

Market jitters, often triggered by perceptions of what might happen, as opposed to what has happened, drive the short-term crude oil price. Major upheavals are rare; more important factors to watch – and which push the price around on a daily basis – are inventory builds, consumer demand data, comments from the oil cartel Opec (whose members tend to be the “swing” producers, raising and lowering output to encourage prices to match their need), and the net trading positions on futures’ exchanges. Keeping abreast of a vast array of data from a multiplicity of sources – and keeping close watch on news “hotspots” such as the Middle East – are imperative for anyone betting on oil.

Unlike oil, the natural gas market has been stuck in a very narrow groove for the past three years thanks to the impact of hydraulic fracturing or fracking. This has turned the US from a net importer of natural gas, either liquefied natural gas (LNG) or via Canadian pipelines, into an exporter. As a consequence natural gas futures now languish around $4 per million British thermal units from above $13 per mBTU in early 2008. Price volatility is relatively low, with a placid trading range of $2-$4.50 per mBTU over the past two years.

As matters stand the US will remain an exporter of natural gas until well into the next century; a very bearish long-term price outlook. “Natgas is one of those great long-term trends, that has persisted despite all predictions to the contrary. With the emergence of fracking there seems little to stop an ongoing downward move in prices,” says Mr Beauchamp. But there is still scope for a downside punt, simply because the fracking revolution will certainly take off in China – not much nimbyism there – and possibly parts of Europe, if planning and environmental concerns do not get in the way. A final twist to the crude oil story is that cheap natural gas could well help cap crude oil prices, by encouraging power generators to switch from oil/coal, and even putting more LNG-powered cars on the road. That $147 a barrel might hold on to its record for quite a while.

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