Tuesday 2 June 2020

Oil trapped between Iran and trade wars: BofAML

DUBAI, May 19, 2019

Opec+ production has fallen sharply, with Venezuela and Iran alone contributing to about 840,000 barrels per day (b/d) of the 2.3 million b/d group supply drop between November 2018 and April 2019, said the Bank of America Merrill Lynch (BofAML) in a new report.

In contrast, global oil demand growth has decelerated sharply in recent months, averaging just 680,000 b/d in the past two quarters compared to trend demand growth of 1.46 million b/d in the past 5 years, said BofAML’s latest Global Energy Weekly.

Weakness in manufacturing may drag down services if trade wars eventually hurt consumer sentiment. In a global downturn, Brent could slip to $50 per barrel (/bbl). On the other hand, under a US-China deal scenario, business confidence may return with a vengeance, resulting in a weaker USD and stronger global growth. If a cyclical global demand upturn coincides with an IMO2020 boost, Brent crude oil prices could spike to $90/bbl.

Oil vol has increased modestly driven by macro

The evolving situation in Venezuela and particularly Iran is complicating things further, the report said.

Chances of a military conflict in the Persian Gulf keep rising as the US pressures Iran. But partly because global oil inventories are balanced, oil options markets are ignoring these risks. True, oil volatility has already started to increase in the past few weeks.

However, when looking at the fundamental drivers behind the recent jump in oil volatility, much of the surge has been driven by macro, not micro factors. In BofAML’s models, the VIX alone explains over 70 per cent of the increase in oil volatility in the past month. This implies oil vol markets are underpricing Iran risks. In part, oil prices have been relatively stable because supply (less Iranian/Venezuelan barrels) and demand (less business cyclical demand) drivers are partly offsetting each other.

Chances of a tail event have increased substantially

This apparent price stability is deceiving, in our view. Front-to-third month contract Brent crude backwardation is now at the firmest level since 2014, pointing to the tightest oil market conditions in half a decade. Yet global oil demand is also at its weakest point in the past 3 years. These cross-currents of supply and demand are likely suppressing oil price volatility.

More importantly, BofAML believes oil markets are underpricing tail risks over the next 12 months. December 2019 Brent options imply only a 10 per cent chance of a jump in oil prices above $90/bbl and a 6 per cent chance of prices falling below $50/bbl.

With military tensions rising in the Middle East and trade tensions rising between the US and China, chances of a tail event driving Brent crude to these price extremes is higher than what option markets are currently pricing, said the BofAML report. – TradeArabia News Service


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