Thursday, April 29, 2010

Oil Volatility Sinks as Shortage Concern Eases: Energy Markets

By Alexander Kwiatkowski

April 28 (Bloomberg) -- Crude oil volatility is falling to the lowest level in almost three years as brimming stockpiles and rising OPEC investment in production capacity eases concern of shortages.

Oil’s 50-day historical volatility, a measure of how much crude fluctuates around its average price during that period, declined to 23 percent yesterday, the lowest since July 2007. The measure rose to a record 108 percent at the beginning of 2009 as prices collapsed following the demise of Lehman Brothers Holdings Inc. and the onset of global recession.

The Organization of Petroleum Exporting Countries said it is planning 140 oil projects over the next five years and that its 6 million barrels a day of unused production is enough to meet demand and avoid a repeat of the price swings of 2008. U.S. crude stockpiles rose to 356 million barrels on April 2, the highest since June, and inventories held on ships are climbing, according to Morgan Stanley.

“When inventories go up, the precariousness of the market starts to fall as there is so much of this stuff sloshing around,” said Michael Lewis, head of commodity research at Deutsche Bank AG in London. “People are not so fearful of a supply event because spare capacity is higher.”

BP Plc, the biggest oil producer in the Gulf of Mexico, said yesterday that crude’s declining volatility may limit profits from its trading this quarter.

Oil has held between $69 and $88 a barrel in New York this year and is up 3.1 percent amid speculation the global economic recovery will spur demand. Prices slumped from a record $147 a barrel in July 2008 to $32 in December that year.

Creeping Higher

Crude oil for June delivery fell for a third day, dropping 1.4 percent to $81.29 a barrel on the New York Mercantile Exchange at 10:56 a.m. in London. Fluctuations have abated as prices have moved “gently” through successively higher price ranges during the past few months, said Paul Horsnell, head of commodities research at Barclays Capital in London, unlike the rapid price swings of 2008.

Oil’s diminishing price swings also reflect increased liquidity, a phenomenon seen across most asset classes, Lewis said. Governments and central banks provided an estimated $11 trillion to rescue financial institutions and cut interest rates to spur the economy.

In stock markets, volatility has decreased for the Standard & Poor’s 500 index, falling as low as 9.6 percent last week on the same 50-day historical basis, the lowest since June 2007. The measure jumped yesterday to 10.8 percent after equities tumbled the most since February as credit-rating agencies downgraded Greece and Portugal, spurring concern Europe’s debt crisis will derail the global economic recovery.

Goldman’s View

The measure of natural gas’ volatility increased to 42 percent yesterday after falling to an eight-month low of 35 percent on March 29. Gas futures traded in New York, prone to swings during the summer hurricane season as storms threaten to halt offshore production, traded near $4.22 per million British thermal units yesterday.

Goldman Sachs Group Inc. analysts Jeffrey Currie and David Greely said in a March 31 report that commodity markets are set for “violent price spikes,” as investment constraints on new supplies and emerging market demand threaten shortages.

Barclays’ Horsnell said that price swings may intensify as global oil demand grows faster than supply and spare production capacity diminishes. Barclays Capital estimates that West Texas Intermediate crude will average $85 a barrel in New York this year, then rise to $97 in 2011.

Predictable Prices

“Volatility is going to be related to the amount of slack there is in the system,” Horsnell said. Barclays sees “a steady erosion of spare capacity and that is a recipe for high volatility.”

Traders attempt to profit from an increase or decrease in price swings by purchasing or selling options contracts.

When volatility is expected to rise, investors may use a strategy known as a long straddle, in which they buy both a call option and a put option on the same commodity, at the same strike price. The buyer gains in relation to how far the price of the underlying stock or commodity moves, regardless of the direction, while their potential losses are limited to the cost of the options.

Saudi Arabia, OPEC’s biggest producer, has sought to rein in oil, expecting that more predictable prices will allow producers to invest the billions needed to meet future demand. The nation has spare capacity of about 4 million barrels a day, Khalid al-Falih, the chief executive of state-run Saudi Aramco, said in an April 19 speech.

OPEC’s Capacity

OPEC, supplier of 40 percent of the world’s oil, pumped 29.2 million barrels a day in March, with another 5.6 million barrels idle, according to data compiled by Bloomberg. The group’s spare capacity was as low as about 2 million barrels a day in July 2008, when oil prices peaked.

Saudi Arabia’s spare capacity acts as a “bridging loan” to meet future demand, said Lawrence Eagles, head of commodities research at JPMorgan Chase & Co. in New York.

While OPEC has been increasing production, “it has been behind the curve in adding supply to meet demand,” Eagles said in an e-mail. “OPEC’s failure to respond to higher prices with higher output today has market implications that could result in a much more serious thrust higher,” he said.

OPEC Secretary General Abdalla El-Badri said on Feb. 1 that the group will add 12 million barrels a day of capacity over five years. The extra oil more than offsets field declines and is enough to “satisfy demand and provide a cushion of spare capacity,” he said.

--With assistance from Grant Smith in London. Editors: Rob Verdonck, Mike Anderson.

To contact the reporter on this story: Alexander Kwiatkowski in London at;

To contact the editor responsible for this story: Stephen Voss at

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