Oil futures posted their largest gain in more than a year last week and are on course for another weekly gain despite a resilient dollar. The frenzy was even bigger in the options market.
Traders snapped up December calls on Brent crude to bet on oil reaching $100 or higher, with aggregate call volume hitting a record after tensions escalated in the Middle East. Meanwhile they snapped up outlandish bets on the futures curve structure rallying heavily. More than 5 million barrels wagered on the nearest Brent spread hit $3.
The call skew on second-month WTI futures jumped to the highest since March 2022, when Russia's shocking invasion of Ukraine sparked supply concerns.
That marked a sharp turnaround for hedge funds, commodity trading advisors and other money managers that raced to reverse positions that had turned bearish on crude in mid-September. Implied volatility for December calls climbed more than 30 points last week, more than triple that for puts, while there was almost no change for either bullish or bearish positions for July contracts and onward.
"Fundamental energy investors … are using call options as opposed to chasing the rally in crude to get upside exposure to a potential supply disruption." said Rebecca Babin, senior equity trader at CIBC Private Wealth Group.
Harris' Headache
Geopolitical risk premium gauges in the oil market have decreased slightly this week, Goldman Sachs said. The bank expected a peak upside of $10-$20 for Brent in the case of supply disruptions in Iran.
However, in the absence of major disruptions, prices could stabilize around current levels this quarter, the bank said in a note dated Tuesday. It all depends on if Israel will target Iran's oil industry. Iran has previously threatened to disrupt flows through the Strait of Hormuz which is a crucial channel through which approximately one-fifth of the world's daily oil production passes.
"In the case of a full-scale war, Brent would likely soar above $100, with any potential shut-in of the strait threatening prices of $150 or more," Fitch Solutions wrote in a note. Gulf states are lobbying Washington to stop Israel from attacking Iran's oil sites because they are concerned their own oil facilities could come under fire from Tehran's proxies, sources told Reuters.
During meetings this week, Iran warned Saudi Arabia it could not guarantee the safety of the Gulf kingdom's oil facilities if Israel were given any assistance in carrying out an attack. "If oil prices surge to $120 per barrel, it would harm both the US economy and Harris' chances in the election. So they (Americans) won't allow the oil war to expand," the source said.
Saudi's Discomfort
Saudi Arabia is ready to abandon its unofficial oil price target for crude as it prepares to increase output, according to the FT. This came as non-OPEC producers were loosening their taps. The shift in thinking represents a major change of tack for the kingdom, which has led other OPEC+ members in cutting output since November 2022 in an attempt to stabilise the market. A decade ago Saudi Arabia increased output in an effort to thwart the rapid emergence of the US shale industry, and as a result, oil price felt the greatest pains in 6 years.
Unconventional Oil Remains Resilient Despite OPEC+ Price War
Despite ongoing price wars, unconventional oil has shown remarkable resilience. The International Energy Agency (IEA) reports that OPEC+'s market share has fallen to historic lows due to output cuts implemented since 2022.
Currently, the country is producing 8.9 million barrels per day (bpd), the lowest level since 2011, reflecting its significant spare capacity. This reduction in output may partly stem from frustration with compliance among member nations. Several OPEC+ members, including Iraq and Kazakhstan, have exceeded their production quotas, while Riyadh has shouldered a substantial portion of the overall cuts.
Additionally, Moscow may face financial strain to support its war economy, increasing the likelihood of it deviating from the agreed output limits.
Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.