Oil markets known for their volatility

Back in February 2005, OGFJ ran a headline on the cover of the magazine that asked - "Can Oil Reach $150?" At the time, there was considerable disbelief this was possible because oil had never sold at such a high per-barrel price.
Feb. 11, 2015
5 min read

Back in February 2005, OGFJ ran a headline on the cover of the magazine that asked - "Can Oil Reach $150?" At the time, there was considerable disbelief this was possible because oil had never sold at such a high per-barrel price. That month, WTI was trading at about $58/bbl on its way gradually to a high of $142 in July 2008 before plummeting to $46 in January 2009 - just six months later.

That surely demonstrates the extreme volatility of oil prices in the past decade. But that hasn't always been the case. For nearly three decades, from 1946 until 1973, oil prices remained low and relatively stable. If you look at this on a graph, the line is remarkably flat for those 27 years. This was the era when fixed contracts were in place and commodities trading was not a major factor in crude oil pricing.

Then along came what is commonly referred to as the "Arab Oil Embargo" in 1973. Many Arab nations sought to punish the US and Western Europe for their support for Israel in the so-called "Yom Kippur War" that year in which Israeli forces prevailed. Led by Saudi Arabia, the Arab nations in OPEC cut off oil supplies to the Western countries that supported Israel causing an abrupt spike in oil prices. This quickly led to shortages and high prices at the gas pump. Most people over 40 remember waiting in absurdly long lines at gasoline stations and just hoping there would be fuel left by the time they got to the pump. In some cases, fuel was rationed by the station owner.

Amazingly, OPEC and Saudi Arabia still hold sway over global petroleum markets, and consequently crude oil prices, even though the US currently imports less than 9% of its oil from Middle East producers. The problem this time isn't a shortage of supply - it's a glut caused by an excess of crude produced in North America, mainly from tight oil plays.

Of course most US and Canadian producers don't accept responsibility for the oversupply situation. Apparently, they expected Saudi Arabia and other OPEC members to reduce their production to keep prices stable, as they had done in the past. Instead, the Saudi oil strategy - if not OPEC's - changed from keeping prices stable to holding on to market share. In other words, the Saudis have the ability to withstand a sustained low-price environment in order to eliminate smaller and more vulnerable shale oil producers, and thus, reduce soaring crude oil production in North America.

So, in recent years - since 1973, oil prices have been characterized by their volatility. We can mainly thank commodity traders for that since they profit from sudden increases and sharp declines. Traders tend to react to small nuances that might affect supply and demand changes, including political unrest in oil-producing regions of the globe. This means that oil prices can spike upward as quickly as they might drop.

Traders and much of the world is currently watching Saudi Arabia following the death of that country's 90-year-old monarch, King Abdullah, on January 23. Abdullah ascended to the throne upon the death of his half-brother King Faud in 2005.

During his nearly 10 years in power, Abdullah arguably had more control over oil prices than anyone on the planet. Here's what IHS vice chairman and Pulitzer Prize-winning author Daniel Yergin said about the late king: "King Abdullah lived an extraordinary life. He was already 14 years old when oil was discovered in Saudi Arabia in 1938 - a little-noticed event with an impact far beyond what was imaginable at the time. With a keen sense of the geopolitical balance and risks, he became the world's most influential oil decision-maker well into the 21th century."

Abdullah will be succeeded by Crown Prince Salman bin Abdulaziz Al Saud, age 79. If the succession in authority goes smoothly, oil prices probably will not be affected by the transition in power. However, if there is any indication of conflict, including political strife, it could shake up oil markets.

Back in February 2005, Oil & Gas Financial Journal featured respected energy analyst Bernard Picchi on the cover. Over the years, Picchi has been recognized 12 times by Institutional Investor magazine for his work in the energy sector, and he spoke with Oil & Gas Journal's Paula Dittrick for our cover story in April of that year.

Picchi told Dittrick, "Until a cushion of energy production capacity can be restored to the market, prices are more prone to rise on bullish news and fall on bad news. There's even a possibility of a 'superspike' in oil prices - $100 to $150/bbl - in the event of a calamitous loss of production somewhere in the world."

He added that if oil prices were to go the other way and drop suddenly, he believed oil stock prices might dip in the short term but would hold their own again.

After running that cover with Picchi's prediction of $150 oil prices, a number of industry people wrote to tell me that thought this was impossible. Turns out Picchi wasn't that far off in his comment when prices climbed to a few dollars shy of his prediction in 2008.

When it comes to oil prices, one thing is certain: What goes up must come down, and what goes down will eventually go back up again. The only variable is when. We could all make a lot of money in the commodities markets if we knew the answer to that question.

About the Author

Don Stowers

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