No markets are inoculated from (not-so-) sharp and (not-so-) sudden trend reversals that ultimately turn out to be healthy corrections. Yesterday’s weakness bears all the hallmark of one as the underlying driving forces have not gone away. It was probably the result of a variety of factors: Brent and RBOB hitting technical upside targets, the persistent strength of the US dollar, unexpected jump in Canadian inflation, a wobble in US consumer confidence, and a disappointing API report.

The general view, nonetheless, has not changed. Geopolitics is still seen as a supportive element of the equation and the renewed rally in equities, founded on rate cut hopes and the seemingly insatiable appetite for AI stocks, helped keep the mood sanguine. No doubt, investors will closely follow the US presidential debate tomorrow and the release of the US PCE Index on Friday. It will provide further clues whether the Fed is inclined to lower borrowing costs before the November election and is expected to show a slight decline both in headline and core readings. The first round of the French elections held on Sunday could profoundly rattle the euro.

The more immediate concern, however, is the latest data on US oil stockpiles. The ubiquitous view is that demand will increase during the summer and with OPEC+ cuts fully in place until October global and OECD stocks ought to deplete. Thus, convincing stock draws in the US would go a long way to bolster this optimism. Last night’s API data was inauspicious. Both crude oil and gasoline went against forecasts and built, and distillate inventories recorded a surprise plunge. If the data set is confirmed by the EIA this afternoon the retracement might just last longer than anticipated.

Returning to the Status Quo

There is no denying that futures trading has been probably at its most challenging in the past 4 years. The outbreak of the Covid 19 virus in 2020 led to unprecedented demand destruction and when it was coupled with a brief but ominous supply war between Saudi Arabia and Russia the price of the US crude oil benchmark plunged into negative territory; sellers, for a short period of time, were willing to pay for getting rid of barrels of the expiring WTI contract in April that year. Just as the global economy recovered Vladimir Putin decided to attempt to solve perceived or actual grievances against the West by using 20th century methods in the 21st century and launched his military campaign against Ukraine pushing the globe into yet another crisis.

One of the many impacts of these hopefully once-in-a-millennia events was tenaciously felt in the futures markets, especially after the Russian aggression. Volatility increased, accordingly margin calls skyrocketed, and futures trading volumes inevitably suffered. Average daily volatility on the two major crude oil futures contracts spiked to 68% on WTI and 56% on Brent in 2020. It then fell back to around 30% the following year only to increase again to advance to 47% and 44% respectively after Russia’s incursion into Ukraine.

Average daily volumes (ADVs) were equally affected. The impact of the health crisis to a certain extent and the break-out of the Ukrainian war undeniably had severe repercussions on trading strategies, particularly on products. Zeal was in short supply. The 2022 ADVs on RBOB, Heating Oil and Gasoil were significantly below that of registered in 2019. On the CME RBOB ADV declined from 198, 000 contracts to 139,000 contracts during these four years, a plunge of 30%. It was matched by ICE Gasoil, whose ADV was down by 96,000 lots, from 318,000 contracts to 223,000 contracts. The loss of volume on Heat was somewhat moderated, its ADV was down 16%, from 172,000 lots to 145,000 lots. The aggregate ADV of the five major futures and options contracts trading on the CME and on ICE dropped from 3.1 billion bbls in 2019 to 2.5 billion bbls 3 years later, a decline of 18%.

As the above data set illustrates, products were hit harder than the two crude oil futures contracts and for a good reason. As volatility jumped, initial margin calls increased, and liquidity dried up, those who were still willing or had to participate in the oil market naturally turned to the instruments with the deepest liquidity pools, ie. WTI and Brent. Thus, there was a clearly visible increase of crude oil weight in the whole trading basket and although ICE is the better example of it, a similar trend is observed on the CME. The resultant relative volumes of the individual components, therefore, more accurately reflected liquidity, bid-ask spreads than the underlying fundamentals; both outright and spread values were distorted, the very nature of an uncertain trading environment.

Staying on this side of the Atlantic Ocean it is intriguing to note that in 2019 Brent ADV was 73% of the combined ICE volume with Gasoil soaking up the rest (27%). This ratio in 2022 changed to 80/20, an obvious sign of the increased and forced relevance of the crude oil contracts at the expense of products. The good news is that the process of normalization has seemingly started. Firstly, volatility has come considerably lower and has averaged at 23% on the European crude oil market year-to-date, the lowest since 2014. Secondly, Brent’s share of ADV has been on the retreat from the 2022 peak and descended to 78% last year and was 76% during the January-May period this year. On the CME product ADVs are also re-gaining their fair share. This discernible re-alignment towards to historic norms makes us to believe and hope that once again what we are experiencing in the futures markets is driven by fundamental factors and not by adjustments to the unforeseen eventualities although there are no guarantees that the outlook will remain the same, let alone improve further provided the precariousness and the unpredictability of the global geopolitical/geoeconomic landscape. 
 

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