Analysis-Oil Prices Turn More Volatile As Investors Exit The Market
3 mins read
Published on August 22, 2022
Traders and fund managers have left crude oil markets in recent months, dropping activity to a seven-year low amid the worst global energy crisis in decades as investors become unwilling to deal with persistently high volatility.
The exodus of participants, especially hedge funds and speculators, has made daily price swings far greater than in previous years, making it harder for companies to hedge against physical purchases of oil. The volatility has harmed companies that need energy market stability for their operations, which includes oil-and-gas companies, but also manufacturing and food-and-beverage industries.
Brent crude futures are swinging sharply on a daily basis. Between Russia's invasion of Ukraine on Feb. 24 through Aug. 15, the daily range between Brent's session highs and lows averaged $5.64. For the same time period last year, the average was $1.99, a Reuters analysis of Refinitiv Eikon data showed.
The high volatility is delaying increased capital expenditures that would help supply keep pace with energy demand, said Arjun Murti, a veteran energy analyst. When volatility is high, oil companies have less confidence in price forecasts, he said.
"There will be concern that prices could fall back to lower levels that wouldn't justify new capex," Murti told Reuters.
Many different types of investors, including banks, funds and producers, have exited the market, participants said, as the market on some days surges on threats to supply, while on other days the cloudy economic outlook causes equally wild selloffs.
Overall open interest in the futures market has fallen nearly 20% since the start of the Russia-Ukraine conflict, according to data from JP Morgan. Open interest in Brent crude futures at the start of August sat at 1.802 million contracts, the lowest since July 2015, according to Refinitiv Eikon data.
The "story is primarily driven by speculators, trend-followers and macro-focused funds looking for a hedge against an economic slowdown that is being priced in by the market," Ole Hansen, head of commodity strategy at Saxo Bank in Copenhagen, told Reuters.
The volatility has had a severe impact on businesses in 2022, a July survey from Schneider Electric showed. Twenty-four of 100 companies in industries including energy, manufacturing and construction firms said it has severely affected their business, the survey showed.
Forty-three percent of companies said energy budgets are the biggest operational area affected by supply-chain disruptions, which have stemmed recently from the coronavirus pandemic and geopolitics.
"The huge increase in energy prices has created an imbalance in procurement, budgeting, and production that we are finding increasingly difficult to maintain," said a survey respondent in the manufacturing and industry sector.
Seventeen percent of the companies said they were either not at all confident or just slightly confident in their organization's ability to hedge against future volatility.
Because of declining market participation, oil prices are moving around $25 per barrel for every 1 million barrel-per-day variation in supply or demand, JP Morgan said. That is nearly double the $15 move before Russia's invasion, it added. This creates a cycle in which the wild swings make investors less inclined to trade the markets.
"The amount of open interest generally starts to fall when there's a lot of uncertainty and direction," said Tony Scott, vice president of Energy Analysis at FactSet. "You wait to pick your spots as the fundamentals become clearer on where things are going."
The consolidation could also signal that hedge funds that invested in the market a year ago are simply taking profits, he added.
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