Despite the sharp price swings in oil, WTI oil remains at the 80s and Brent oil at the high 90s. The big swings in oil prices might be due to the high uncertainty in the markets, the recent developments in Europe and speculations around the oil market from both the demand and supply sides. According to the recent EIA report, the crude oil stockpiles are still near the high levels recorded in 2011 and are 1.4% above the five year average. Let's examine the recent developments in the oil market that could explain the sharp movement in the oil market.
Despite the sharp swings in oil prices during the past couple of months the price of WTI declined by only 1.8% during June and up to date the price rose by only 1%. The price of United States oil also moved in a similar rate during those months. Despite the low movement on a monthly scale, the daily changes in oil have been erratic and this high volatility is presented in the increase in standard deviation of the daily percent changes in WTI oil during June and July.
(Click to enlarge)
There are some factors that could explain the recent high volatility in oil including:
- The sharp swings in the euro/USD; despite the rally in the euro at the end of last month, it still declined in the past couple of months; if the euro will continue to trade down against the USD, this could also adversely affect oil prices; during June/July the linear correlation between oil and euro/USD reached 0.76;
- The concerns over the economic growth in leading economies; this factor is plausibly the main factors that keeps oil prices from hiking; if China, Europe and U.S won't show high growth, it could cool down the oil market from heating up; the IEA didn't updated by much its oil forecast demand for 2012 and 2013; today China's GDP for Q2 will be released; this report could also affect the oil market;
- The concerns that the strike in Norway of energy workers could affect the oil production of one of the leading oil producing countries; the strike has ended since then; if there will be some ramifications from this strike it might affect the oil market in Europe;
- The concerns over the U.S sanctions on Iran and the embargo of Europe on Iran; according to the recent OPEC report the OPEC's oil production reached in June 31,363 thousand bbl/d; Iran's oil production decreased by 188.5 thousand bbl/d; as a result its production declined below the 3 million bbl per day mark for the first time this year; it Iran's production will continue to dwindle it could tighten the oil market;
- The FOMC meeting at the end of the month; there are those who think the Fed will consider QE3 in the near future; if the FOMC will introduce QE3 this could affect the oil prices;
- The ongoing rise in the OECD oil inventories might suggest the oil markets is loosening up;
Some of the above mentioned concerns may continue to affect the oil market in the near future. This means that for now, oil prices could go either way but I guess oil prices might eventually start to rise (at least for the short term) as the concerns over the supply might crowd out the slowdown for growth in oil demand. In the meantime the high volatility might continue until there will be some big news in any of the above mentioned fronts. The price of oil is strongly correlated with energy stocks such as Chevron Corporation (CVX) and Exxon Mobil Corporation (XOM). During June and July the linear correlation between Exxon's stock and oil price (daily percent change) was 0.52; for Chevron the correlation was 0.59. This means (assuming all things equal), if oil price were to break from their range and increase it could pressure up these stocks. In particular (assuming linearity, and normality) for every 1%, growth in oil price, the price of Chevron could increase by 0.4% and Exxon by an average of 0.3%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
