Saudi Arabian Energy Minister Prince Abdulaziz bin Salman said "extreme" volatility and lack of liquidity mean the futures market is increasingly disconnected from fundamentals and OPEC+ may be forced to act.
"The paper and physical markets have become increasingly more disconnected," he said in response to written questions from Bloomberg News.
Prince Abdulaziz represents the largest oil producer in OPEC+ and is arguably the most important player in the 23-nation alliance. He said futures prices don't reflect the underlying fundamentals of supply and demand, which may require the group to tighten production when it meets next month to consider output targets.
"Witnessing this recent harmful volatility disturb the basic functions of the market and undermine the stability of oil markets will only strengthen our resolve," he said.
Benchmark crude oil futures have fallen markedly in recent weeks in London and New York on concern about the outlook for the global economy and the possibility of more Iranian oil coming onto the market. Brent futures fell below $93 a barrel on Monday, down from more than $120 in June.
Still, open interest and trading volumes remain well below historical levels as the price swings caused by the war in Ukraine scare investors away. The lack of trading is making the market more volatile as the pool of active buyers and sellers shrinks, according to some market participants.
Saudi Arabia and the rest of the OPEC+ group have steadily increased production this year, reversing all of the cuts made during the coronavirus pandemic as demand recovered and Russian supply dropped.
Below is a transcript of Prince Abdulaziz's responses to written questions:
Are you concerned about the current state of the market?
The paper oil market has fallen into a self-perpetuating vicious circle of very thin liquidity and extreme volatility undermining the market's essential function of efficient price discovery, and have made the cost of hedging and managing risks for physical users prohibitive.
This has a negative impact on the smooth and efficient operation of oil markets, energy commodities and other commodities creating new types of risks and insecurities.
This vicious circle is amplified by the flow of unsubstantiated stories about demand destruction, recurring news about the return of large volumes of supply, and ambiguity and uncertainty about the potential impacts of price caps, embargoes, and sanctions.
In your view, how is the current volatility impacting the functioning of markets?
This is detrimental because without sufficient liquidity, markets can't reflect the realities of the physical fundamentals in a meaningful way and can give a false sense of security at times when spare capacity is severely limited and the risk of severe disruptions remains high.
Nowadays, one need not look far for evidence of this. The paper and physical markets have become increasingly more disconnected. In a way, the market is in a state of schizophrenia, and this is creating a type of a yo-yo market and sending erroneous signals at times when greater visibility and clarity and well-functioning markets are needed more than ever to allow market participants to efficiently hedge and manage the huge risks and uncertainties they face.
Will OPEC+ have to respond?
In OPEC+ we have experienced a much more challenging environment in the past and we have emerged stronger and more cohesive than ever. OPEC+ has the commitment, the flexibility, and the means within the existing mechanisms of the Declaration of Cooperation to deal with such challenges and provide guidance including cutting production at any time and in different forms as has been clearly and repeatedly demonstrated in 2020 and 2021.
Soon we will start working on a new agreement beyond 2022 which will build on our previous experiences, achievements, and successes. We are determined to make the new agreement more effective than before. Witnessing this recent harmful volatility disturb the basic functions of the market and undermine the stability of oil markets will only strengthen our resolve.
