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Commodities Corner: Oil’s crazy price moves aren’t really crazy at all

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Believe it or not, there is some sanity to the chaos in oil prices, which have climbed this year to their highest since 2008 only to fall back to their lowest in eight months.

“The market is overreacting to fears either due to expected tightness in supply or, as currently is the case, worries about weaker oil demand due to the threat of recession,” says Ann-Louise Hittle, vice president of macro oils at Wood Mackenzie. “This has triggered a sharp pullback in prices.”

Global benchmark Brent
BRN00,
-3.22%

BRNX22,
-3.22%

and U.S. benchmark West Texas Intermediate
CL.1,
-3.50%

CLV22,
-3.50%

oil on March 8 saw futures prices settle at their highest since 2008, with Brent at $127.98 and WTI at $123.70 a barrel. Both have retreated from those levels, with prices marking their lowest settlements since January, with Brent at $88 and WTI at $81.94 on Sept. 7.

Saudi Arabia’s energy minister, Prince Abdulaziz bin Salman, told Bloomberg last month that the “paper and physical [oil] markets have become increasingly more disconnected” amid extreme volatility and lack of liquidity. “The market is in a state of schizophrenia.” He also said OPEC+ is determined to make a new agreement beyond this year “more effective than before.”

Following his comments, OPEC+—comprised of members of the Organization of the Petroleum Exporting Countries and their allies, including Russia—decided to cut production by 100,000 barrels a day for October, reversing the increase of 100,000 barrels a day for September.

However, many analysts don’t believe there’s any disconnect or distortion in the market. “The current oil-trading market is functioning well and is not suffering from distortions,” says Vikas Dwivedi, Macquarie Group’s
MQG,
+0.14%

 global oil and gas strategist. “The market has had to deal with more binary events over the past two years than just about any period we’ve seen,” contributing to unpredictability, he says.

Supply risks from the Russia-Ukraine war and talk of underinvestment in oil production have helped support oil prices, while pressure on prices has come from China’s economic slowdown due to Covid lockdowns, strategic-oil-reserve releases from industrialized nations, and the potential for an Iran nuclear deal that would lead to more oil on the market.

Oil traders ought to pay close attention to “energy-policy changes across Europe, the way big oil companies are paying management teams to focus on profitability and not increase volumes, [and] ongoing discussions from OPEC+,” says Marcus McGregor, director of investment research at institutional investment manager Conning.

They should also watch developments tied to the nuclear deal with Iran and the “latest trajectory on renewables consumption, and understand what’s baked into current global GDP estimates region to region,” says McGregor. He expects spot oil prices to remain volatile in the near term.

There’s another thing traders should keep in mind: “Commodity markets, oil or otherwise, have never been predictable, and they never will be,” says Pavel Molchanov, analyst at Raymond James.

The oil market is currently in a state of backwardation, where futures prices trade below the spot market, reflecting the expectations that Russia’s war in Ukraine will end, he says. Still, it’s clear this conflict will continue “well into 2023.”

Read: High fuel costs will continue to contribute to the rise in food prices

Raymond James estimates that Russian oil exports have fallen by 500,000 barrels a day since February, so the European Union’s embargo against Russian oil, which takes effect at the end of 2022, should not be underestimated, he says. As long as the war drags on, Russia will be “the No. 1 source of uncertainty vis-à-vis oil supply,” Molchanov says.

“Beyond that, the trajectory of demand will be influenced by macroeconomic trends: central-bank actions in the U.S. and Europe, supply-chain problems, and China’s zero-Covid policy,” he says.

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