“Volatility can be neither created nor destroyed, rather it transforms from one form into another,” is a pretty fair summary of how the oil market works (with apologies to physicists).
The benchmark price of Brent crude has been unusually stable since the middle of December, but there has been plenty of movement in the futures strip and crack spreads.
Hedge funds have amassed an unusually large net long position in crude futures and options betting on a further increase in benchmark prices, but the position has not yet yielded much profit, with prices range bound.
The more interesting and profitable trades for both hedge funds and physical traders so far in 2017 have been around the calendar, crack and quality spreads.
Front-month futures prices have traded in a narrow range of just $3.46 per barrel since Dec. 13, never closing below $53.64 or higher than $57.10.
The standard deviation of front-month prices over the last month, which is one way to measure volatility, has fallen to the lowest level since July 2003.
Some of the reduction in volatility is more apparent than real: as the dollar price has halved since 2014 so a smaller dollar move is equivalent to the same daily percentage change.
Volatility is not exceptionally low when daily price changes measured in either dollars per barrel or percentage terms are considered rather than just the flat price.
Nonetheless, there is no doubt flat-price volatility has declined over the last two months and is now at some of the lowest levels since the oil slump began in 2014.
But while flat prices have been broadly stable, other elements of the constellation of oil prices have become increasingly volatile.
There have been sharp moves in time spreads (between futures prices spreads for crude delivered in different months), crack spreads (between the price of crude and refined fuels) and quality spreads (between different crude grades).
Most traders seem convinced the oil market is shifting from a supply surplus in 2014/15 to a supply deficit in 2017/18.
But most traders are also convinced the rebalancing will occur in an orderly way, with OPEC ensuring prices do not fall below $50 while the acceleration of shale production will cap them below $60.
Between them, the OPEC “put” and the shale “call” define a floor and ceiling for prices in the short term, a temporary trading range or what oil economist Paul Stevens has called “bands of belief”.
Such trading ranges are only ever temporary and are prone to breaking down, but at least while they endure they create a powerful anchor for expectations and can be self-stabilizing.
If market rebalancing is expected to occur within a relatively narrow range of flat prices, relative prices are shifting to make it happen.
The various spreads are shifting to move crude from storage to the refineries, and from oversupplied markets in North America to undersupplied markets in Asia.
Speculative traders are increasingly focusing on the spreads, which likely explains some of the sharp price moves and reversals seen in them over the last couple of months.