When Volatility is Volatile

Risk level: RED

RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)


-There’s no going back to normal.

-BP expects $55 crude at most through 2050.

Reality may have finally descended on the crude oil market. The price for Brent crude oil has been on a remarkable run since its collapse in April, posting double-digit rallies a handful of times since then. Gains of that magnitude are abnormal, though the sense of normalcy in the pandemic age is under attack. Since the quarantine economy emerged with the outbreak of the novel coronavirus, the market has shown a profound disconnect with reality. Projections of steep declines in GDP, rampant unemployment and now a growing and deep sense of public outrage have been met with gains rather than losses in both equities and commodities. In a systemic shock such as this viral outbreak, foundations are re-established. Flickers of normalcy in these market circumstances are indicative of a bygone era rather than a sense of return.

The price for Brent crude oil fell 8% last week after exuberance was replaced by a dose of market malaise. A warning from investment bank Barclays last week that the rally for crude oil was overdone and concerns about a second wave of viral infections finally spooked the market. Former US Central Bank Chief Alan Greenspan wondered more than 20 years ago if irrational exuberance was driving asset values higher than fundamentals supported. What’s irrational now is the idea that the markets, and life as we know it, will return to what we once considered normal.

Retail investors trying their hand at trading using the Robinhood platform and other tools have been able to ride waves that seem to be hidden from plain view. In the US, the Dow Jones Industrial Average surged 500 points last week, coming off one of the worst trading weeks in memory. But volatility has been volatile in all markets since the middle of the first quarter. The British Office for National Statistics on Friday reported that GDP contracted 20.4% in April, its largest decline ever. In the US, estimates for the second quarter are for a contraction of as much as 48.5%, according to the Federal Reserve Bank of Atlanta. S&P Global Platts estimates that a rebound in drilling activity is unlikely until 2022, close to 30 different upstream companies have defaulted on debt and a handful are close to bankruptcy. But so far in June, the price for Brent has closed in negative territory in only three sessions.

The price for Brent may be supported by relief as much as anything. Long gone are the fears that crude oil storage facilities in the United States could overflow. Russia and Saudi Arabia were able to overcome early-year differences to solidify a curtailment agreement that for years supported the price of oil. When that deal unraveled, the price war between the two leaders left visible welts on the market. Now, even countries with a reputation for cheating on their production obligations are committed to discipline.

“We will keep lowering production gradually to comply with OPEC quota,” an Iraqi oil official speaking on condition of anonymity told the Reuters news service.

Question marks over OPEC’s next move emerged when the opposition Libyan National Army, led by rogue Field Marshal Khalifa Haftar, finally succumbed to pressure from the UN-backed government in Tripoli. Libya had the distinct honor of holding the black swan moniker for much of 2019, with political volatility throttling the potential for 1 million barrels per day. The loss of those barrels at the onset of the last decade sparked a collaborative response from the International Energy Agency. The return of those barrels would upset hopes for a balanced market. What happens next in Libya is a concern, but, as with post-quarantine life, to expect a return to normalcy is to expect the unexpected. Secondary sources reporting to OPEC economists put total Libya production in April output at 82,000 bpd and at 348,000 bpd for the first quarter on average.

For the Middle East and North Africa as a whole, the Arab Petroleum Investment Corp. expects energy sector investments to come in some $173 million lower than last year’s five-year outlook. Top brass at APICORP said the market is in the grips of a triple-threat – a coronavirus-related crises, a crisis in the oil market and lingering financial setbacks. Ahmed Ali Attiga, the CEO at APICORP, said the expectation is not for a V-shaped or U-shaped recover, but a W-shaped recovery for the MENA region.

“The impact of COVID-19 is already deeper and longer lasting than past downturns,” he said in a statement. “Indeed, the nature of this triple crisis and the profound restructuring in oil and gas will hit energy investments for a potentially long period of time, sowing the seeds of supply crunches and price volatility.”

We keep waiting for normal to return, but it is already here. On CSPAN during the weekend, William Schaffner, an infectious disease specialist at Vanderbilt University said the second wave of infections has already begun. In the US in particular, the easing of isolation measures is encouraging people to venture out after months of lockdown. People are going out, he said, but are complacent about the threat of the coronavirus and the social-distancing necessary to contain an outbreak.

“You need to train people that wearing the mask is now the new normal,” he said in part.

The accepting of new ways of thinking and new senses of normal are akin to the sun rising in the east. Light slowly breaks on the dawn rather than suddenly shifting from night to day. Transitions, systemic or otherwise, are long processes that redefine our perceptions of reality. The price of oil has been on the rise on hopes that the gradual re-opening of the global economy will bring demand back to early-year levels. But those hopes may prove fleeting. British supermajor BP is writing down some $17.5 billion in assets and cut its forecast for Brent crude oil to $55 per barrel. That forecast holds until 2050 and is a 30% dip from its previous estimate of $70 per barrel. Over a shorter horizon, APICORP projects Brent will likely stay where it is through next year. When what was once unthinkable becomes so common that it’s overlooked or ignored, real change has taken place. For the market, the level of volatility indicates things are still in a transitory phase. For all intents and purposes though, this is the new normal.

It’s a trifecta week, with the US Energy Information Administration, the IEA and OPEC all releasing their monthly market reports for June. The conflicting narratives we’ve come to expect in those reports will be manifested in volatility in the price of oil. A handful of data from the European economy, from German inflation to euro-area sentiment, could be worth watching on Tuesday. Retail sales in the United States, meanwhile, are expected to show a big jump, as is industrial production. But watch for an uptick on coronavirus infections and recent rumors over President Trump’s health to spoil some of the optimism. Numbers on new car registrations in Europe on Wednesday will offer a reflection of the vibrancy of the economic re-opening. For OPEC watchers, a GDP reading from Russia later this week will be telling in terms of commitment. Jobless claims in the United States on Thursday are sure to bring a market bounce. And the week ends with another round of speeches from figureheads at the US Federal Reserve. What was once abnormal — a prediction for a swing in oil prices of at least 4% — is now normal The Red alert holds for the foreseeable future, with Brent expected to move by at least +/- 4% on the week.

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