Can You Spell V-O-L-A-T-I-L-I-T-Y?
The past three days have provided a graphic example of what volatility can do in the oil market.
This is the reason I have emphasized it – from the very beginning of Oil & Energy Investor – as the primary driver of oil prices moving forward. (See “What Crude Oil Prices are Telling Us,” October 1, 2010.)
Volatility does not mean that prices will be moving in only one direction, as the past several days have clearly indicated.
Yesterday’s 8.6% decline in NYMEX crude oil prices concluded athree-day drop of 12.5%. Through the four trading sessions ending yesterday, RBOB had declined 11%.
Both crude oil and RBOB (the New York-traded gasoline) futures contracts are moving back up today. We may well see some range trading for a bit, as the market reacts to the recent price plunge. (In fact, don’t be surprised if you see them weakening late today.)
We just happen to be in the middle of the monthly options cycle, and there are still readjustments in calls and puts to maximize spread before they expire in two weeks.
Nonetheless, this was a very significant adjustment.
Yet such heavy gyrations are not the result of any significant market developments.
Let me repeat that this way: There is nothing happening in the market to justify such a plunge.
So why did it happen – a disappointing preliminary employment figure (prior to the much better one emerging today), continuing concerns over stockpile surpluses at Cushing, OK, or figures indicating greater crude oil inventories at refineries?
No. None of the above.
All of these factors have been in and out of the market for months with no major impact. They are all ultimately coming down on the demand side of the question, looking for indications that demand destruction is on the horizon and – with it – a downward pressure on pricing.
Every once in a while, this mantra becomes a self-fulfilling prophecy. Yet it never tells us very much at all.
Because, despite the concerns expressed over U.S. demand levels, elsewhere in the world it is quite a different story.
This Is A Global Oil Market
Now, this is a very important dimension to the market that it usually overlooked.
Americans emphasize domestic market considerations – supply, demand, refinery capacity utilization – with the idea being that, so long as we can balance the market in the Lower 48, we are insulated from outside pressures.
No longer happens that way.
This is a global oil and oil products market. What happens anywhere has an effect everywhere else.
While the importing of additional amounts of crude oil into the U.S. is on everybody’s radar, few recognize that there are also increasing imports of gasoline, diesel, jet fuel, and (depending upon local market conditions) even asphalt into the American market.
Just one aspect will drive the point home.
As the renewed pressure downwards hits in late afternoon NYMEX trading today (I can almost guarantee on that… just watch it unfold mid-afternoon), where is Brent going in London? It will be in the opposite direction, with the spread between West Texas Intermediate in New York and Brent in London expanding again.
Wrong, Wrong, and Wrong Again
The most ridiculous explanation of all floating about out there is the death of Osama Bin Laden. I have been hearing this by talking idiots on the tube for days.
Somehow, the decline in oil prices is a result of a team of Navy SEALs…?
There is absolutely no correlation between taking out a nasty person and oil prices. It is about as significant as saying his death has boosted the Pirates’ chances for winning the Pennant. (Recall I live in Pittsburgh, and reaching summer around here, thoughts start turning to football and hockey.)
There are no genuine answers out there from the conventional pundits.
Was the market overheated? Yes.
Were the speculators moving prices too high? Yes… That is always the case when the pricing trajectory is moving quickly in one direction or the other.
Did traders wake up a few days ago and find religion? Unlikely.
But none of these “causes” make any real difference, anyway.
The market remains the same, and the dynamics of that market remain the same. Crude oil pricing will continue to increase, despite the “correction” this week.
Here is the important thing to remember about all of this: An investor will make his or her primary return from trading the volatility correctly… not simply trading the price level.
So take a deep breath.
A rocky ride is getting rockier… but there are profits at the other end.
[Editor's Note: The Portfolio for Kent's trading service is set up to profit from situations just like this. Take a closer look at his Energy Advantage, which shows individual investors how to make the real money in energy.]