Sparked by the Russian invasion of Ukraine, and the potential of up to 3 million bpd loss of Russian supply, the extreme volatility in oil markets is here to stay, as traders have slashed open interest in oil futures to a seven-year-low.
The less liquid market is thus more prone to wild price swings, as seen in just two weeks, in which oil jumped and slumped by US$40 a barrel in both directions. Since the beginning of March, oil prices have been more volatile than in the 2020 crash at the onset of COVID-19 and the start of the 2008 financial crisis.
The CBOE Crude Oil Volatility Index (INDEXCBOE: OVX) has jumped by 80% year to date to March 17.
There’s much more volatility ahead in the near future, analysts and investment banks say. Reduced liquidity on the oil futures market will translate into more severe jumps and crashes, depending on the daily and hourly headlines from the Russian invasion of Ukraine, the status of the Iran nuclear deal, the hit to demand from surging energy prices and inflation, or the loss of Russian supply due to sanctions and self-sanctions.
Since the beginning of the war in Ukraine, traders and speculators have been cutting their open interest in crude oil futures to spare themselves losses from the extreme volatility in prices.
Portfolio managers cut their bullish bets on Brent Crude by the most in years in the week to March 8, according to data from futures exchanges. The spike in oil prices and the heightened volatility has led many hedge funds and speculators to close out long—or bullish—positions.
The combined open interest across six energy futures—Brent, WTI, RBOB gasoline, heating oil, gasoil, and European gas—reached a five-and-a-half-year low on March 11, Ole Hansen, Head of Commodity Strategy at Saxo Bank, said early this week.
“Rising volatility is forcing portfolio managers to reduce their exposure while traders cut position sizes,” Hansen said.
Moreover, futures exchanges raised initial margins significantly after Putin’s war in Ukraine began, thus making trading the same amount of oil futures much more expensive.
“The market is un-tradable, given the volatility,” hedge fund manager – Gary Ross, at Black Gold Investors LLC who is a veteran oil consultant, told Bloomberg.
“The volatility was too hard to stomach,” a paper trader at a large trading firm told Reuters’ Julia Payne, commenting on the crash in open interest, which makes the market less liquid and thus, prone to the wildest swings in history.
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The surge in prices has led to giant margin calls across the commodities complex since Russia invaded Ukraine at the end of February.
Even one of the largest independent commodity traders, Trafigura, is reportedly looking for financing outside its usual pool of banks, Bloomberg reported this week, citing sources with knowledge of the matter. Trafigura is said to be in talks with Blackstone for an up to US$3billion funding deal, after the trading group faced multibillion-dollar margin calls last week, according to Bloomberg.
Via futures contracts in commodities, trading houses hedge against risks. Without commodity derivatives, many traders would not be able to move physical volumes of oil.
The European Federation of Energy Traders (EFET), whose members include Trafigura, Vitol, Shell, and BP, among others; has urged European central banks for “time-limited emergency liquidity support to ensure that wholesale gas and power markets continued to function”, the Financial Times reported, citing a letter the federation sent earlier this month.
“The overriding objective is to keep an orderly market for futures and other derivative energy contracts open,” Peter Styles, executive vice-chair of the EFET board, told FT in an interview.
Meanwhile, volatility in oil markets is set to continue amid uncertain outcomes in the war in Ukraine, the Iranian nuclear deal, the hit on demand from inflation and interest rate hikes, and COVID-related developments.
“To say that oil prices have been volatile recently would be an understatement,” analysts Martijn Rats and Amy Sergeant at Morgan Stanley wrote in a note carried by Bloomberg. Morgan Stanley now sees Brent at US$120 a barrel in the third quarter of 2022 – up by $20 per barrel from its previous forecast.
