Investors now realize that demand fuels oil prices, and the risk to price now is when supply is overabundant, there is no demand for it. The decline in production globally has brought supply and demand to an equal playing field much faster than anticipated, and Brent crude has hit $52 a barrel.
Hans Van Cleef, ABN Amro chief strategist, says, “In the end, you will see global oversupply, at some point diminish, and in effect even earlier than speculators realize.”
In the past 12 months, close to a million barrels per day (bpd) have been diminishing U.S. output, who is one of the culprits when it comes to the surplus. In addition, series of misfortunate events around the globe have become rampant in the last five years, halting production in certain countries affected and slowing down the overproduction.
Volatility is highest on extremely non-profitable options that give their owner the flexibility, but not the obligation, to decide the selling price of oil by a set date, solidifying investor’s fear in having a potentially drastic change in the market.
Standard Chartered’s Paul Horsnell said, “It’s part of that switch from moving from pricing inventories being accumulated to trying to price up how fast inventories will be run down. It’s a different trading structure. Everything starts and finishes with ‘what sort of market is this? Is there excess demand or excess supply?’… As soon as you start saying it’s in excess demand, then a lot of those factors that are driving time structure and the volatility surface, which was ‘there’s a risk of running out of inventory storage space and storage is going to be full to the max’ … go out of the window.”
Volatility on out-of-the-money puts expectations a year from now at $35.35 a barrel, around 45 percent, compared to 35 percent for one week’s time with a strike price of $49.42. This switch suggests investors are indeed looking to a hopeful near future with oil pricing, eliminating any concerns from the overabundance in crude.
Horsnell said, Highlighting this growing faith in oil’s prospects for this year, is the shrinking of the premium, or contango, of Brent futures contracts for delivery of crude further ahead over those for prompt delivery.
The contango between the two futures is less than half of what they were just three months ago. Van Cleef continues, “…You see signals that global economic growth may be fragile, but there is still growth, especially in emerging Asia and oil demand will remain solid there. So that will balance the market in the second half of the year and therefore justifies current prices, if not even higher prices.”
Article written by HEI contributor Marcela Abarca.