Oil’s sharp swings are a symptom of a changing market
‘What would have happened in one week is happening in one day,’ one executive said “The computerization of the (oil) market is modifying volume and liquidity,” one expert says.
Computerized trading is playing a greater role in the oil market, helping to amplify the volatility that has accompanied crude’s recent downward lurch.
While geopolitical tensions and economic concerns have sent oil prices spiraling, analysts and traders say the shifting makeup of the market has exacerbated swings, with traditional players like supply-and-demand focused hedge funds, market makers and banks scaling back.
“The computerization of the market is modifying volume and liquidity,” said Jean-Jacques Duhot, chief investment officer of Arctic Blue Capital Ltd. “What would have happened in one week is happening in one day.”
On Nov. 13, for example, the Cboe Crude Oil Volatility Index notched its biggest one-day gain since 2011of 39%. That day, crude futures capped a record streak of 12 consecutive sessions of losses. Nov. 20 also saw a 30% gain in oil volatility, as prices plunged nearly 7% to a one-year low.
Oil prices have lost about a third of their value since hitting multiyear highs in early October.
An unexpected influx of supply, coupled with growing economic uncertainty, sent prices sliding and upended calls for $100-a-barrel (U.S.) crude.
U.S. prices dipped below $50 a barrel at the end of November and closed at $51 a barrel Monday, down 3.1% on the day, after lingering skepticism followed a rally Friday when the Organization of the Petroleum Exporting Countries and its allies agreed to production cuts.
Goldman Sachs attributed the recent volatility to algorithmic traders exerting more influence in the oil market, according to a Nov. 26 report.
That is partly because there are fewer discretionary commodities funds to make bets based on supply and demand signals. Earlier this year, longtime oil investor T. Boone Pickens closed his energy-focused fund, BP Capital, and Jamison Capital Partners LP shut down its $1.5 billion flagship fund. Last August, legendary oil trad- er Andrew Hall closed his main fund at Astenbeck Capital Management LLC.
Trading algorithms in the oil market generally buy and sell based on price patterns, ignoring fundamental information, which could magnify one-way moves as such programs pile into market trends.
“With no discretionary money to take the other side, market liquidity is drying up, which reinforces the momentum to the downside,” analysts at Goldman Sachs wrote.
Bullish speculators who bet on higher oil prices fled the market as crude tumbled. In oil and refined products markets, open interest, which denotes the number of outstanding futures and options contracts, has fallen to its lowest levels in about two years, according to Goldman Sachs research.
Along with heightened volatility, some traders have noted lower volumes and liquidity on days of major price moves. Liquidity in the most active crude futures contract is about onethird of what it was in September, as measured by average daily quote size, according to Quantitative Brokers, which designs algorithms for executing futures trades.
“You’re balancing between getting the order done for the client and minimizing the impact that you’re having in the market,” said Ralf Roth, chief executive of Quantitative Brokers. “Naturally if there’s less liquidity, that becomes more challenging. The order just takes longer to execute.”
Mr. Roth said the last time the oil market experienced a similar decline in price and liquidity was at the end of 2015, in the middle of a plunge.
The oil market dwarfs other commodities in trading volume, and traders said they have yet to see major issues in executing orders.
“An illiquid day in crude oil is much more liquid than an illiquid day almost anywhere else,” said Douglas Hepworth, chief operating officer at Gresham Investment Management LLC, a $7 billion commodities firm.
But with geopolitical uncertainty likely to keep fundamental investors cautious as the year draws to a close, the oil market remains vulnerable to outsize moves.
After OPEC and its allies completed the deal to curb output, U.S. oil prices traded as much as 5% higher and closed up 2.2%.
Traders expect the market to remain on edge and wary of U.S. policies on Iranian sanctions and how the administration will react to the production cuts.
“Very rarely have we ever had to think about, in the oil market, what the president of the United States wants,” said Scott Shelton, a broker at ICAP PLC. “It’s subtracted players. They can’t find their way through the geopolitics.”