Analyst Vito Turitto explores why the Dated Brent market was in backwardation in September and why Dated Brent's volatility is expected to increase in the coming weeks. Strong Asian demand and abnormally high refining margins encouraged the market structure in September, and crude prices spiked on geopolitical events. But looking forward, both the International Energy Agency and OPEC foresee more demand for crude, and market imbalances will continue to have an impact on prices and volatility.
Learn more in the October 2017 Volatility Analysis: EMEA.
Brent crude oil volatility: October outlook
By Vito Turitto, manager, quantitative analysis
Welcome to the Snapshot, a series examining the forces shaping and driving global commodities markets today.
The Dated Brent market has been in backwardation for the whole month of September. The persistent and aggressive backwardation in the Brent CFD forward curve, which encouraged market participants to sell their barrels as quickly as possible in order to take advantage of the good economic conditions, has been favored by two factors: rather good demand coming from China and South Korea and abnormally high refining margins that encouraged refiners to maximize their runs.
Asian demand and refining margins encouraged Dated Brent backwardation in September
The incredible arbitrage opportunity, given by the large WTI/Brent spread caused by hurricane Harvey, has pushed many market participants to focus on cheaper American crudes. In fact, in October, something like 250,000 b/d coming from the USA are expected to compete with BFOE grades in the North Sea.
Internationally, the spike in crude prices and the backwardation in the ICE Brent futures market have been favored by several factors.
IEA and OPEC expect higher crude demand in Q4 2017 and in 2018
First of all, the International Energy Agency raised its expectations on oil demand for 2017, forecasting its growth could achieve 1.6 million b/d by the end of the year. And secondly, OPEC estimated that the demand for its crude grades would go up and reach 32.6 million b/d in 2017 and 32.8 million b/d in 2018.
Geopolitical instability prompted spike in Brent Prices at end of September
However, the big spike in Brent prices, which happened at the end of September, has been mainly caused by the geopolitical instability in the Kurdish region of Iraq, which includes the oil-rich province of Kirkuk. The region voted in a referendum for independence and more than 92% of the ballot backed a separation from Baghdad, which is against this decision.
These factors greatly influenced the fluctuation of the price. In fact, the volatility premium went up by more than 600% in only 21 trading days. The remarkable increase in the volatility premium is predominantly due to a drop in the Brent swap realized volatility, while Brent’s implied volatility continued to move sideways.
The premium will likely shrink in coming weeks with the realized volatility increasing more than the implied one. Nevertheless, once the equilibrium point is reached, the divergence between the volatilities is expected to remain stable.
Dated Brent’s volatility closed the month of September trading at 22.3%, which means that it was fluctuating within the 20-25% interval. However, the volatility will probably increase in coming weeks and settle around the 25-30% interval where it has more than 18% chance to remain.
The volatility cones analysis shows that the current volatility curve remains well below the low-range one but its monthly and bimonthly figures are even lower than the back end of the curve. The fact that the front end of the curve is still close to the lowest point touched over the last two years is a clear consequence of the market imbalances caused by the aforementioned geopolitical and natural events. Hence, the volatility will likely mean revert in the coming weeks.
Nevertheless, given the great influence that those events still have on market equilibrium, it is likely that the front end of the current volatility curve will move up but won’t surpass the low range one.
Brent volatility to increase only in the short term
Consequently, Brent prices are likely to retrace in the short term but then they will tend to gradually stabilize and progressively uptrend.
Brent prices to move up in coming weeks
Until next time on the Snapshot — we’ll be keeping an eye on the markets.