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A few years ago, in one of my books ("The Vega Factor"), I coined a phrase to explain the new way in which oil pricing was unfolding, along with the uncertainty resulting from it.
Then, the market was facing rising crude topping $100 a barrel.
Now, the situation finds oil rising into the mid-$60s after a bout of abnormally low prices.
The phenomenon described, however, applies to oil moving in either direction.
I called it "Oil Vega."
Simply put, it refers to the increasing inability to determine the true value of crude oil based on its market price.
Now, there is a reason why I'm revisiting this phrase now.
You see, I am close to putting the finishing touch on a new investment tool that identifies stocks based on this phenomenon.
And today, I want to give you a sneak peek at one of its main components...
Decoding the "Oil Vega"
Before we begin, I want to explain a little more about the origins of the term "Oil Vega."
I originally borrowed the concept of vega from options traders. As traders use it, "vega" relates to the way in which the price of an option reacts to a change in volatility.
They need to determine a value for the option and be able to revise their estimates on that value as market changes take place in the futures contract on which it is based.
For that, they need a pricing model.
The volatility component in their pricing model, from which one determines a theoretical value for the option against which a trader calculates the option's market price, is called implied volatility.
Simply put, vega represents the rate of change in the theoretical value of an option as it relates to a change in implied volatility.
But there is one other important matter to consider here.
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Vega is a "second order," or derivative concept to the actual change in the value of a security. It measures the amount by which the price of an option reacts when volatility changes. Volatility is simply the measurement of how often and by what amount a market factor changes.
My book then explored how the rising inability to determine actual value was playing out in a market where oil prices were progressively being driven by what traders could gain in futures contracts, rather than actual consignments of the underlying oil.
Now, I recently discussed some of the ramifications in equating "paper barrels" (futures contracts) with "wet barrels" (oil in trade) and the rising problem of derivatives as a consequence.
Today, I want to introduce the new factor upon which my new stock-picking approach will be based on.
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Is Another Round of Instability and Volatility Headed Our Way?
The pressures prompting the 2014 to 2016 decline in oil prices were outside the normal supply-demand cycle.
Put simply, two factors intervened:
- The fallout from a protracted credit-liquidity-finance crisis, and the corresponding worldwide recession resulting from it
- Political intervention by OPEC to defend market share rather than price
Most analysts still adhere to the idea that removing such exogenous elements will allow oil to return to some degree of normalcy.
Unfortunately, my analysis reveals something else.
All the components are now in place for another round of price instability and volatility.
There are two overarching reasons for this.
First, the Oil Vega is coming back into focus as the merging of paper and wet barrel forces becomes more difficult to accomplish, resulting in new generations of derivative paper.
Second, there is no longer an "outside."
Credit, liquidity, finance, and political intervention are now staple parts of the oil market, not exceptions to it.
We are now witnessing stabilizing oil prices, along with signals that demand is returning.
It is well known that increasing levels of energy demand regularly precede major upward corrections in the market as a whole.
That does not happen merely because people wake up one morning feeling more confident about their consumption rates or lifestyles.
It is because energy usage is a front-end support requirement for a rise in leading indicators, with the recovery taking place well before it registers in lagging indicators.
In other words, energy in general - and its dominant constituent, oil, in particular - will experience an increase in demand at an early stage of a recovery process, before that recovery is recognized in wider economic sectors.
Now, as the Oil Vega intensifies, the public sector will have to step in to deal with the problem.
I would also suggest that, as the uncertainty over pricing intensifies, the political factor will figure even more prominently.
In fact, it will be the political arena, rather than the market, that will ultimately decide much of the matter.
Warning: Crisis Ahead
Unless there is a genuine global strategy in place, a prolonged crisis may ensue.
An extreme result would be conflict over resources, but the more likely outcome would be recurring, oil-based domestic and regional legislative and regulatory decisions impeding free trade, cross-border capital flows, and access to assets.
That could be as damaging and as disruptive.
Much of this we are already seeing from the current White House, where we've seen moves to provide regulatory support for fossil fuels, while at the same time advancing tariff walls against selected imports.
Remember, this comes after the U.S. Federal Reserve artificially pumped in liquidity to combat one crisis while running the risk of producing a "cold turkey withdrawal" when the stimulus ends.
However, elsewhere in the world, the stimulus approach is digging in, rentier nations are placing greater reliance on national oil companies as a broad ingredient in overall foreign policy, and the massive move to collateralize crude oil reserves as a global financial weapon is emerging with the Aramco IPO.
Success on this last endeavor will result in similar moves by other countries.
Rather than sitting on our hands and awaiting an increasingly unrealistic "return to normal," the concept of Oil Vega is emerging as a genuine opportunity.
I initially advanced the idea as a way of explaining what was happening in the oil space.
But it is morphing into a tool for the early selection of investment moves.
The bottom line is, embracing the uncertainty is going to result in some very enticing profit opportunities.
If you aren't a Member of one of these services yet, now's your chance. Not only will they be among the first to try my new investing tool, but they already have access to my weekly stock picks and premium research.
In the meantime, I'll be tracking the developing Oil Vega and will be keeping you updated along the way.
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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.