LONDON – OPEC policymakers seem confident in a sustained recovery of oil prices from this year’s lows as demand improves, but the derivatives market is geared for an alternative scenario: a fall below $50 a barrel by the end of the year.
The level of volatility in the market, a broad measure of risk sentiment that determines the price of an option, has been edging higher.
And for oil derivative contracts expiring in December, volatility has touched its highest in nearly four months, particularly for deeply bearish sell-options.
Typically, December is when producers and consumers hedge their future requirements, prompting volatilities to rise.
But it is also when the Organization of Petroleum Exporting Countries (OPEC) holds its twice-yearly meeting.
OPEC’s secretary-general said on Thursday the group expects increasing oil demand to prevent a further fall in prices and sees a more balanced market in 2016, the latest sign the group is sticking to its policy of defending market share.
Positioning in the options market suggests no respite to the glut that has stripped more than 60 percent off the value of oil since its peak back in 2008.
“What’s happening is the market is coming to terms with the fact that these lower prices have not resulted in any significant change in supply/demand economics,” ICAP oil broker Scott Sheldon said.
A Reuters monthly oil price poll showed on Thursday that a majority of analysts believe prices will recover towards the end of this year to average $60.60 a barrel and $69 next year, when demand from emerging markets improves.
Crude oil options paint a starkly different picture.
Holdings of ICE Brent crude put options, which give the owner the right, but not the obligation, to sell oil at a predetermined price by a certain date, outnumber those in calls — which offer the option to buy — by an average of 2:1 over the coming 12 months, highlighting the bearish bias of the market.
On the benchmark September Brent options contract, a quarter of total holdings of puts are gathered in options that carry the right to sell below $52 a barrel, just below the current price of the underlying futures contract around $54..
For holdings of put options in the December 2015 contract, this percentage rises to almost a third.
The biggest bet in options that could be profitable by the end of the year is contracts to sell at $50 a barrel.
“The downside could be a bit more than maybe people anticipate,” ICAP’s Sheldon said, adding that $50 a barrel by the end of year looked likely, based on the options market.
“Certainly demand has picked up in gasoline and in distillates, but it just hasn’t been enough and we haven’t seen the supply response that the market was looking for.”
Further along the futures curve, the ICE Brent December 2015 contract has fallen more than 16 percent so far this year, compared with the benchmark contract’s roughly 8 percent decline.
BNP Paribas analyst Harry Tchillinguirian said he was more upbeat on the crude oil price and anticipated a rally towards $69 by late 2016, from the current $53 a barrel, but added that right now, using options to protect against more drops in price was reasonably cheap.
“Certainly, there a lot of people who are concerned about price weakness and how this weakness may extend beyond the third quarter and are prepared to buy puts,” he said.
Questions over demand growth in key emerging markets like China, relentless output from OPEC and U.S. shale producers, along with Iranian crude returning to the market after an historic nuclear deal are key supply-side negatives.
The options market is not suggesting Brent will go into the kind of free-fall witnessed in the second half of 2014 that took 60 percent off the price. But for now, it suggests the only way is south.
“We have concerns about crude fundamentals and prices in the second half of this year and 2016,” wrote Morgan Stanley in a note last week.
“Demand is near seasonal peak levels and will fall into the second half of this year, OPEC production has grown significantly … As we look to 2016, sanctions could be lifted on Iran,” Morgan Stanley said, adding that it could not see a significant break higher in prices next year.
(Reporting by Amanda Cooper; Editing by Veronica Brown and Giles Elgood)
This article was from Reuters and was legally licensed through the NewsCred publisher network.