Price volatility in crude markets coming down

The dollar weakened slightly against other currencies, pushing crude dollar prices slightly higher by week's end. Also, the nearby New York futures crude contract expired, forcing hedgers to roll over positions into the next trading month.

These elements pushed nearby crude prices above $50 per barrel in New York, with the June contract closing out the week at $51.55, a gain of $1.93 in one day, and a strong gain from the week's crude price low of $46.72 on Tuesday before recovering to close the day at $48.55. Oman DME crude also had a choppy week.

It gained $1.65 on Friday, to close the week at $50.50 per barrel for the physical, while the financial settlement contract was little changed, but hit a low on Tuesday of $47.52 per barrel, before closing the day at $48.65 per barrel.

Traders were also eyeing the future, basing nearby prices on what it foretold, which is mostly positive for crude demand. The likely line of thought is as follows: Last year, crude traded above $140 per barrel, because of demand rising faster than supply, and because of there being no cushion of surplus production capacity available.

Now traders see some cutbacks in upstream crude development and imagine that once the current economic crisis has subsided, the world will again see demand rising faster than supply. This realisation is pushing up back futures contract prices, which, with the future guiding the present, lift current month prices.

Heating oil, the hedging contract for all middle distillates, fell strongly early last week, opening at $1.43 per gallon and ending at $1.32 on Monday. But by week's end it had gained back much of the ground, ending the week at $1.37.

The Commodity Futures Trading Commission's Commitment of Traders report last week showed little change from the previous week, when commercial hedgers established small futures positions offering some protection from falling prices in the physical market.

Also, last week's Commodity Board Options Exchange's OVX crude price volatility index ended the week at 52.81, down sharply from the previous week's close of 69.45.

This is a vote by options traders that price volatility in crude markets is calming down. There seems to be more confidence that crude prices, for all their intra-week volatility, have surprisingly steady inter-week price movements.

This means that price changes during the trading week are likely due to local news of interest to traders, with few residual broad-based consequences for crude markets in general. It fits a pattern of crude markets being very news sensitive during the swing months of April and May, when refiners gear up for the summer driving season and reduce heating oil production.

The upward pricing bias seems to be in place, as it is hard for some to understand how, with declining nearby demand, and with crude inventories close to all-time highs, crude prices have failed to reflect these economic fundamentals by falling further. But in cyclical markets like crude oil with its long lead times and supply insensitivity it is logical that traders will react more to market psychologicals rather than to fundamentals.

- Dalton Garis is Associate Professor of Economics and petroleum market behaviour at the Petroleum Institute, in Abu Dhabi.