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Brent crude oil volatility: August outlook

With Vito Turitto, manager, quantitative analysis

August 10, 2017 14:03:52 EST (5:48)

Analyst Vito Turitto sees August likely being a sideways month with crude oil prices tending to oscillate within a trading channel that probably will be a lot more downside biased than upside. In fact, it is unlikely that Dated Brent prices will move higher than $54.50 and it is improbable that they will fall below $50/b.

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Video Transcript


The month of July opened with Faroe Petroleum announcing that tests on its Brasse oil discovery in the North Sea have produced a flow rate of 6 thousand 2 hundreds b/d of light grade crude.


Furthermore, Statoil announced another Barents Sea discovery showing that the oil potential in the Norwegian side of the North Sea and in the less explored Barents Sea is far from over and could dramatically increase Oseberg crude volumes beyond expectations.


In the first half of July, many Dated Brent cargoes were in the hands of bullish players, in fact, despite the amount of floating storage was around 7.55 million barrels on July 4 and the far from aggressive Far East demand, the CFDs forward curve remained in backwardation for almost 2 weeks.


Needless to say that the amount of floating crude acted as a cap on prices and around July 13 the backwardation in the CFDs forward curve started to fade away as a consequence of the fact that, the already not so strong, Far East buying pressure began to weaken whilst the convergence of many VLCCs at the ship-to-ship transfer area in Southwold certainly did not help boosting market sentiment.


Market conditions deteriorated even more around mid-month when the amount of BFOE barrels stored in floating tankers reached 14 million. However, the contango in Brent rolls started to become a problem because the CFDs structure was not enough to pay for floating costs.


Nevertheless, despite the uneconomical conditions in the forward curve, the barrels on floating tankers kept going up and reached around 10 million on July 24.


Things changed around the end of the month when the front end of the CFD forward curve moved into backwardation thanks to the Saudi announcement that it would limit its exports to 6.6 million b/d in the month of August.


Internationally, the focus of the majority of market participants was still on Nigeria and Libya because their productions went up again, in fact, in July, they extracted 1.78 million and 810 thousand b/d whilst comforting news came from the United States.


Specifically, the US Energy Information Administration reported that US crude oil inventories dropped by 6.3 million barrels on July 8, by 4.7 million barrels on July 12 and by 7.2 million barrels on July 21 dragging the American crude oil stocks below the 500 million barrels threshold.


OPEC MEMBERS' COMPLIANCE TO PRODUCTION CUTS FALLS TO 78%


Nevertheless, market participants remained cautious because of 3 factors: the International Energy Agency, in its monthly report, stated that compliance to the production cuts among OPEC members had dropped to 78% whilst the Energy Information Administration stated that the US oil production had risen to 9.3 million b/d and that the number of drilled but uncompleted wells, in June, grew to a record 6 thousand and 31 with crude oil production coming from unconventional plays forecast to rise to 5.5 million b/d only in the month August.


The Volatility Premium analysis shows that the premium has always been positive throughout the whole month indicating that the implied volatility has consistently been higher than the realized one.


The option market, being predominantly used for hedging purposes, has likely experienced an increase in volatility because the skepticism, which still runs high among market participants, led many of them to hedge more as Brent prices continued to soar pushed by speculation rather than by a real change in fundamentals.


BRENT MARKET LIKELY TO OSCILLATE WITHIN A TRADING CHANNEL


Nonetheless, the fact that the volatility premium is getting back to normal implies that the market is likely to move sideways, everything else being equal.


The Probability Distribution analysis confirms that the fluctuation rate will likely not stay around 28% and that it will tend to go up and move towards the 30-35% range, which is Brent’s volatility equilibrium point, where it has a more than 23% chance to remain.


VOLATILITY LIKELY TO INCREASE IN THE SHORT TERM


Finally, the Volatility Cones analysis shows that an increase in volatility should be expected in the short term and that could likely imply a drop in prices but the market should stabilize in the short-to-mid-term.


Overall, the month of August will likely be a sideways month and prices will tend to oscillate within a trading channel that probably will be a lot more downside biased than upside. In fact, it is unlikely that Brent prices will move higher than $54.50 and it is improbable that they will fall below $50/b.





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