The volatility in the oil market has notched up this week, courtesy of another bout with debt jitters in Europe. Oil and gasoline futures are moving down – and most of the energy sector along with them.
In a situation like the current European debt mess – where maximum uncertainty is channeled into a very focused concern – oil futures will generally overcompensate, exaggerating the downside.
Of course, that is of little consolation to the traders who in the past few days have seen about $3.00 cut from the near-month futures (July).
What the Market is Saying
We are just into the next month of options (this one-month cycle ends June 18), and the prevailing trend in calls remains up. That is, the preponderance of plays on the call side (buying options) are in a range betting on a price of between $27 and $31 for the iPath S&P GSCI Crude Oil Total Return Index ETN (NYSE: OIL).
(For some context, that exchange-traded note (ETN) closed yesterday (Tuesday) at $25.91, an increase of 56 cents – or 2.21% – per share.)
This ETN is the most direct way for average investors to participate in crude oil futures, with options on OIL the least-risky way of insuring against high volatility.
It is not anything intrinsic in oil supply and demand that is prompting this volatility.
This one is all about what the renewed concerns over Greek and Italian debt are doing to perceptions of European oil demand and the exchange rate between U.S. dollars and European euros. In fact, the dollar is improving against the euro – another sign that the debt problem is pressuring forex.
With NYMEX West Texas Intermediate (WTI) crude prices down further than Brent crude prices, one might wonder how a European debt problem could be having a greater impact in New York than it is in London.
The spread between WTI and Brent has been a lingering concern for almost a year. At current prices, that spread has intensified from an average of about 13% of the WTI price over the past 10 trading sessions to almost 16%.
This tells us two things:
First, it tells us that the primary impact of European debt has been working into Brent pricing right along, augmenting the downward volatility that was already being experienced in the market during the last week.
And second, this tells us that the pressure ends when the debt crisis abates. This is not oil-market-induced pressure. It is exogenous to the market.
Stay the Course
We can, of course, point out that the weight of debt can depress the demand expectation and, as a result, push the price down. Yet in the current circumstances, the default prospect is quite low.
Neither Brussels, nor Athens, nor Rome will allow that. Whatever pressure we experience will be short-term.
And this is what the OIL options are telling us.
Despite the protracted concern and distraught remarks from the tube's talking heads, the debt situation will resolve. If it does not, the entire Eurozone is in peril. And despite the angst that possibility prompts, the likelihood of that is remote.
It's simply not going to happen. So stay the course, folks.
Dr. Moors' impressive body of work also form the backbone of the Energy Advantage, an energy-sector advisory service that enables investors to capitalize on his unrivaled industry access, contacts and insights. For more information on that service, please click here.]
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About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.