Oil has become too volatile for traders | OilPrice.com

Price volatility is a trader’s daily bread, but in oil volatility becomes excessive, pushing traders away and making life more difficult for many companies that normally use oil hedges to provide some price stability that is vital to their operations. This is according to a Reuters analysis who notes that oil prices have become so wild in their daily swings that the usual suspects, such as hedge funds, are leaving the oil market in droves, with activity there falling to a seven-year low.

So it appears that volatility is only a good thing up to a point, and that point appears to be a daily price range five times greater than usual. According to Reuters analysis, between February 24 and August 15 this year, the daily range for Brent crude averaged $5.64 a barrel. That compares to $1.99 a barrel last year.

The withdrawal of speculators is only one of the problems of such volatility in oil prices. The fact that companies in the food industry, for example, do not dare to protect themselves against further price fluctuations affects their business. And it also affects the activities of the oil industry itself.

An analyst quoted by Reuters explained that oil companies are wary of capital spending due to excessive volatility in oil markets. And because they are suspicious, these companies are delaying projects that could help rebalance the oil market, Arjun Murti told Reuters.

Speaking of the oil industry, it’s not just the current volatility that’s interfering with potential production growth. It is also the uncertainty about future demand as the transition movement gathers pace.

In a recent Houston Chronicle article, James Osborne wrote that forecasting oil demand was becoming increasingly difficult amid developments such as the now notorious Inflation Reduction Act that Congress passed earlier this month.

With all these incentives to electrify transportation and shift to renewable power generation, the future of oil demand has darkened, he argued, even according to Big Oil.

Related: Gas price in Europe now equals $410 a barrel of oil

Arguably, most Big Oil is heavily involved in the energy transition, which could cast a shadow over the credibility of its oil demand forecasts. Yet the fact remains that many governments are determined to have a transition, whatever the cost, and that is bearish for oil demand.

The latest transition surge in Europe and the US has likely made a bad volatility situation worse by clouding the demand outlook as everyone can see with a keen eye that demand for oil, right now, is stronger than many had expected, especially as some utilities in Europe switch from gas to oil due to prices.

That proved too much not only for speculators but also for industry players in the oil market, according to Reuters analysis. Open interest in the oil futures market has fallen by a fifth since Russia invaded Ukraine as traders apparently weary of the price swing from tight supply and inflation fears.

What the future holds is, as always, impossible to say, but the price picture is unlikely to change anytime soon. This means that the negative effect of this price volatility on companies in all sectors will continue, fueling the aforementioned swing in oil prices.

Businesses will continue to need energy of limited supply, but high energy prices will continue to threaten their growth prospects and those of their respective economies. Governments, meanwhile, will continue to pump money and laws into the energy transition, further discouraging the oil industry from doing anything meaningful about procurement.

By Irina Slav for Oilprice.com

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