(MENAFN- Gulf Times) Oil's biggest price swings in three years are poised to continue as Opec cedes no ground to competing suppliers.
Oil traders' expectations for future swings, known as implied volatility, surged since Saudi Arabia and fellow members of the Organisation of Petroleum Exporting Countries decided on November 27 to keep pumping crude despite a supply glut. That will mean prices fluctuating in the next several years by even more than the $58-a-barrel move in 2014, Bank of America Corp says.
"Opec has always been there to lower volatility both on the upside and downside, but now they have less and less weight," said Pierre Andurand, the London-based founder of Andurand Capital Management, whose $350mn fund earned 18% in November from betting on lower Brent crude prices. "It means more volatility."
Opec's policy of testing rival producers' tolerance for lower prices has sparked the search for a new equilibrium, increasingly shaped by the readiness of US shale drillers to sustain projects as returns shrink. Last year's drop in Brent is threatening investment in new crude supply, creating the potential for more volatility in years to come. Futures are down 49% in London, the most since 2008.
Implied volatility for front-month Brent futures reached 49.7% on December 22, the highest level since August 2011. It climbed by 3 percentage points the day after Opec's November meeting, then slid almost 9 percentage points through to December 5, before pushing higher. Brent has fallen 27% since the day before the group's session in Vienna.
"Saudi Arabia has for years been the main balancing agent in the market," Sabine Schels, an analyst at Bank of America, said by phone from London on December 16. "Now they're telling us, 'We're not doing this anymore.' They're likely to let the market trade in a much wider range."
Adjustments by Saudi Arabia have steered global output levels for decades, cushioning sudden supply shocks. A 1.5mn bpd drop in Libyan production during the 2011 uprising against Muammar Gadaffi was matched by a corresponding increase by the world's biggest oil exporter, data compiled by Bloomberg show. Higher volatility, which Saudi Arabia is better placed to withstand than shale drillers, is itself a strategy for curbing rival supplies, according to Bank of America.
"Volatility benefits low-cost producers with strong balance sheets, i.e. Saudi Arabia," Schels said. "Volatility hurts small players that are highly levered, that have weak balance sheets, i.e. US shale producers."
The average borrowing cost for energy companies in the US high-yield debt market almost doubled to 10.43% by mid-December from an all-time low of 5.68% in June, Bank of America Merrill Lynch data shows. Energy producers have raised $550bn of new bonds and loans since early 2010 as the Federal Reserve held borrowing costs near zero, said Deutsche Bank. Researcher CreditSights Inc predicts the default rate for energy junk bonds will double to 8% this year.
About $930bn of investment in global oil projects through 2025, generating 7.5mn bpd production or about 8% of current demand, is at risk if Brent remains below $70 a barrel, Michele della Vigna, an analyst at Goldman Sachs Group in London, said in a December 15 report.
The "damage" being inflicted on investment in new production by collapsing prices is creating the conditions for a rebound over the next two years, said Andurand, the hedge fund manager who called the top of the oil market in 2008.
Trading in Brent, a global benchmark grade, has expanded. Open interest, or contracts outstanding, was at 1.493mn on December 29, from last year's low of 1.292mn on August 18, data from the London-based ICE Futures Europe exchange shows.
Elevated volatility boosts interest in the $1.25bn US Oil Fund, the biggest exchange-traded product tracking the value of crude, according to John Hyland, the chief investment officer of the fund's Alameda, California-based manager. Shares outstanding in the fund rose to 63.9mn on December 23, the most since June 2010.
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