Dated Brent-ICE Brent crude oil futures volatility premium analysis for June shows that Brent’s implied volatility was completely unresponsive and did not react at all to the downtrend that dragged prices down and that the current divergence between Brent realized and implied volatilities remains very low.
Analyst Vito Turitto sees the inverted leverage effect and the ongoing contraction process in the Brent crude oil market as factors likely to increase volatility, with the outlook for Brent prices negative over the coming weeks.
Video Transcript
Welcome to The Snapshot – our series which examines the forces shaping and driving global commodities markets today.
The Dated Brent market, at the beginning of June, has been once again characterized by numerous ship-to-ship transfer offers (Forties and Ekofisk above all) and a lack of demand coming from the Far East and in particular from China.
The absence of any arbitrage towards Asia and a steep contango in the Brent CFDs forward curve, which definitely incentivized many market participants to buy and store crude, pushed the numbers of barrels stored on floating tankers up to 7.3 million in mid-June.
Clearly, the aforementioned scenario in the North Sea put BFOE grades under pressure and the additional production coming from Libya and Nigeria certainly did not help easing the burden on sweet grades.
Things began changing around the middle of the month as some of the floating barrels began making their way into domestic demand and some cargoes departed towards South Korea.
However, the market remained fairly well supplied. Around June 20, thanks to some buying pressure coming mainly from South Korea, the improved market conditions pushed the Brent CFD curve higher, flattening the contango and consequently reducing the incentive to keep barrels in floating tankers.
Nevertheless, the demand from the Far East was far from aggressive and the quantity of floating storage achieved 9.7 million barrels on June 22 because the shifting in the CFDs forward curve was predominantly fueled by expectations of better arbitrage conditions.
The South Korean and Chinese demand for BFOE grades, Forties above all, became more active in the last trading days of June as the arbitrage opened up new opportunities bringing the front-end of the Brent CFD forward curve into a mild backwardation on both June 28 and 29.
Nevertheless, the shy buying activity was undoubtedly not big enough to counterbalance the selling pressure caused by the large amount of circulating crude and the not-so-strong Asian demand.
OPEC OUTPUT REACHED 32.49 MILLION B/D IN JUNE
Internationally, the OPEC output increased by 220 thousand b/d bringing its total to 32.49 million b/d meaning that the total production of the cartel went up by half a million b/d in only 2 months.
The figures coming from the United States were not that encouraging either: first of all, the Energy Information Administration forecast that the shale oil production was expected to achieve 5.47 million b/d in July.
Secondly, the International Energy Agency, in its monthly report, stated that the balance in the market would be achieved only around the end of the year or at the beginning of the 2018 and thirdly the number of American active oil rigs went up again and reached 747.
VOLATILITY TO INCREASE
The volatility premium analysis shows that Brent’s implied volatility was completely unresponsive and did not react at all to the downtrend that dragged prices down and that the current divergence between Brent realized and implied volatilities remains very low, indicating that more market turbulence should be expected in coming weeks.
SELLING PRESSURE MIGHT BE YET TO START
The fluctuation rate did not move much during the sell-off indicating that the market has followed an inverted leverage effect process which is a symmetrical movement between price and volatility.
The inverted leverage effect process is usually a warning signal which indicates that the trend is far from robust and that the real selling pressure might be yet to start.
In fact, it is rather unusual for the Brent market to lose $4-$5 in less than 20 trading days without having an effect on the oscillation rate but, given the fact that the sell-off happened soon after the OPEC meeting, it is very probable that many market participants were actually expecting such a retracement.
The probability distribution analysis indicates that the volatility will likely tend to increase and reach the 30-35% range where it has more than 22.5% chance to remain and settle.
Finally, the volatility cones analysis confirms that the current volatility curve remains below its long term equilibrium implying that a mean reverting movement should be expected in the coming weeks.
NEGATIVE OUTLOOK ON BRENT
Overall, the inverted leverage effect and the ongoing contraction process in the Brent market are factors likely to increase volatility so the outlook on Brent prices is negative.
Until next time on the Snapshot—we’ll be keeping an eye on the markets.