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Op-eds & Essays by Jamie Webster • March 07, 2019
Concerns about oil market volatility and its impact on companies and consumers are part of a narrative stretching back long before the rise of the “lower for longer” era for crude prices.
But volatility has come into sharper focus due to a series of significant market changes, led by the shorter development cycle of shale, the increased sway from Opec’s partnership with Russia and other producers, and the growing willingness of the US to utilise energy sanctions to meet its foreign policy goals.
The result has been oil price swings that have unsettled investors.
For those looking to put money into oil projects, heightened volatility can have a huge impact on investment decisions, especially in an environment where lower long-term prices mean the margin of error for investments has become much smaller.
Given the effects on producers, traders and communities that depend on oil revenues, a view of volatility needs to move beyond the binary and directionally descriptive, and towards its potential multi-fold impacts.
It is no longer enough to say that oil market volatility is rising or falling — a key factor for the profitability of traders — but it needs to be understood in the context of the new market reality.
The character and impact of oil volatility has changed since the initial 2014 price decline from above $100 a barrel.
The annualised price range over the course of the four years prior to the 2014 price fall averaged $30.27 a barrel, while the average in the four years since 2014 has been just $20.59 a barrel.
But a $20 price range is felt far more keenly when the average annual price is closer to $60 than $100.
This focus on volatility is borne out in the data of the 30-day implied volatility index, which rose sharply in late 2018, in tandem with the dramatic fourth-quarter price decline, when Brent crude tumbled from above $86 a barrel to below $50.
This elevated level still fell far short of the 2016 levels — the year of the beginning of the initial price recovery — and has subsequently fallen as price choppiness has abated since the beginning of the year. Over the longer term, implied oil volatility has grown 12 per cent in the four years since the price decline relative to the four years prior to it.
There have been more fundamental changes to how volatility influences behaviour.
Prior to 2014, changes in oil prices largely affected end user choice such as whether to buy an SUV or a smaller car, or an industrial end user deciding to reduce oil costs through efficiency investments or transitioning to another fuel.
But since the 2014 price fall these volatile price changes more directly impact producers and particularly smaller, marginal producers as they make decisions about specific projects.
Put more broadly, before the price fall of 2014, price volatility would impact on the relative profitability of a project as well as how much producers were willing to spend, but often not cause the project to be uneconomic. When the price swung around a $100 pivot point it did little to slow the industry’s overall rise in upstream investment.
Yet in the past four years, nearly all project types — from short-cycle shale to the traditional megaprojects once favoured by the supermajors — have had to weather prices below investment levels for at least some of the year.
While fewer project types were affected in 2018, this type of volatility is likely to remain elevated even as cost discipline may help to drive break-even levels lower.
This dynamic may have less of an impact on the largest companies which have balance sheets and longer-term planning and strategy horizons that are less disturbed by short-term oil price swings.
But it impacts smaller producers — particularly US shale producers, as well as the communities that rely on the investments to sustain growth.
Ultimately, merely describing or forecasting volatility as higher or lower is now insufficient, and instead defining what that means for the industry, affected communities and end users is necessary for the future understanding of oil market dynamics.
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Op-eds & Essays by Jamie Webster • March 07, 2019