Trading and Risk

Risk Analysts Take Note—High Oil Market Volatility is Here to Stay

byRob McBride

2020 has been quite a roller coaster ride—and it’s not even halfway over yet.

To be sure, in recent weeks WTI crude reached a little bit of oil price stability compared to what we have been experiencing. But by no means is market volatility in the rearview mirror. In fact, the kind of volatility WTI experienced is likely here to stay for quite some time. We can expect to continue seeing volatility for the rest of this year and next.

Volatile market ripples are spreading these effects across all commodities. Trade shops that manage risk across multiple commodities will find that these issues only compound themselves and continue to add to confusion and volatility.

What are the key energy market themes today?

  • Unprecedented times. If I have to use the phrase “unprecedented times” one more time, it will be too soon. There is no measurement stick in history to compare what we’re currently going through.
  • Remember OPEC and the price war? The Saudi-Russia price war has ended. But it was the catalyst for the market volatility this year.
  • Demand-destroying impacts of COVID-19. Most of us didn’t travel anywhere for weeks as global lockdowns were in effect.
  • Prisoner’s dilemma amid breakeven crude prices. We’ve seen green shoots of demand coming back. The market is rallying back into the $40s, is the enthusiasm too soon?
  • Forty-dollar oil—to drill or not to drill? In the $40 price range, operators will go forward with drilling (or not drilling) decisions. Forty dollars doesn’t solve all problems.
  • Uncertainty will lead to “unprecedented” volatility … and managing forward curves will be more important than ever.

The volatility is not measured in months or years, but in days, hours, and minutes.

Crude oil prices have had a year to remember. We started out the year at healthy near-term prices of more than $60 a barrel. Around March is when the Saudi-Russia oil price war began, and that caused a huge collapse. But even a nearly 50% drop in prices doesn’t look too astounding when compared to the historic negative price plunge in mid-April.

Here’s a little historical perspective of the volatility experienced in WTI markets.

In the chart above, you see the 2018 forward curve in blue, the 2019 forward curve in red, and 2020 in orange. For 2018 and 2019, the forward curve snapshot was gathered mid-year. In all three cases, the forward markets were showing a strong and steep backwardation, or a market where forward prices are weaker than prompt-delivered supplies, which is often the case when demand is expected to continue to grow.

Here’s what happened next. The chart above introduces the WTI forward curve in March 2020—the volatility that seemed strong previously was suddenly dwarfed by what came next. The Saudi-Russia price war brought on an extreme contango, which means that market is expecting near term oversupply necessitating the incentive to store for future use.

Let’s now introduce the May WTI futures contract on its expiration date—April 20, 2020. By this point, the COVID-19 pandemic had set in and obliterated demand. What we once thought was very strong volatility looks very tame compared to what we’re seeing nowadays.

The final chart shows where the WTI futures market returned to in June. It looks like a recovery now, but it’s certainly too early to say there’s any guarantee that demand has returned.

So, where does that leave us today? Today, managing your volatility and managing your risk is literally more important than it ever has been before. These events are likely to repeat themselves over the next 12 months. While we may not see another negative futures settlement, it is not necessarily ruled out. It had never happened before, but it may happen going forward. And we certainly could experience negative physical prices again in the field.

What does oil demand look like now across the globe?

In 2019, we were continuing our very steady increase in demand. What was expected to happen, a continuation to the slow growth, was obliterated.

The annual demand destruction we’re expecting for 2020 has never happened before. Our Enverus base case now shows a total 8.7 MMBbl/d hit to global crude demand. A longer outbreak in 2020 could drop demand by a stunning 11.4 MMBbl/d. Three to four years out, we are still not recovering to the demand levels we were expecting before the pandemic hit.

Elevated market risks are likely to make operators more conservative, requiring higher returns for future investments. Risk management tools like CurveBuilder can solve a number of issues risk analysts face today. For a demo of the cutting edge technology, sign up here.

This will likely repeat itself because of the supply and demand uncertainty, for which we have no historical comparisons. As demand recovers, substantial increases in prices will be required to drive a recover in tight oil production.

Rob McBride

Rob McBride

Rob McBride is the Sr. Director of Strategy and Analytics at Enverus. He previously managed natural gas trading at Hess and BNP Paribas, and served as the director of business development of energy markets products at Bloomberg LP.

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