With crude oil prices being traded at two-year lows despite the latest rush in Middle East upheaval, investors might be absolved for wondering what happened to peak oil.
The reality is that despite the major sums that have been invested in another optional energy with the supply of oil from shale proving to be much greater than expected, oil prices were confirmed to be nine times higher than just over a decade ago.
Most of the recent fall can be attributed to a rally in the dollar as the market factored in the conclusion of the quantitative easing and the likelihood that the U.S. is more likely be the first major western economy to increase its interest rates. Oil, just like any other commodity, being prices in dollars has a likely inverse correlation to the actual value of the said currency.
However, there is a far more significant technical effect at work which substantial leverage that became fixed in the forward curve. Ever since the financial crisis, there has been a disintegration in the financial market volatility. At first, that was considered as normalisation from elevated levels. But as it became apparent that the initial policy response from central banks were not at any time soon going to be reversed, volatility will eventually cascade.
Volatility in commodity markets is normally driven by various distinctions in supply instead of demand, as price is the only real device to ration demand when faced with an abrupt shortage or surplus.
In spite of the concerns plaguing the Middle East, there has been more production coming back into the mainstream, instead of going out. The chaos in Syria has had only limited impact on oil production. Iraq is exporting once again and Iran may possibly do the same in the long run. Elsewhere, the U.S. presently supplies far more oil than it actually needs and the economic depression in Europe has resulted to lower demand from refiners.
The Brent oil market has toggled from near-term tightness which was in excess demand to one in which there is a surplus in supply. In future markets this is represented by a move from backwardation where the present prices are comparatively much higher than future prices.
The effect has been bolstered by the lack of volatility, with risk management industry tools such as value at risk use volatility as a primary key input. Therefore, a market with low volatility seems to be safe and risk management departments would allow much bigger trading positions.
When the terms of the playing field are changed, the amount of capital looking to exit could easily overcome the market.
The next few remaining months should provide a much wider perspective into the real stability level. In the 2002 recession, prices were hardly above $10 and in the past six years it bottomed at $30. Since the quantitative easing began , there was hardly any showing below $90 with peak oil or not, prices have tripled in each of the past two-year periods.