Crude Oil has been witnessing low volatility in line with financial assets but much steeper compared to that which suggests that factors specific to the industry are at play.Barclays observed in a report that the soothing effect of a marked stabilisation in oil supply and demand is also at work. In the past three years, annulal oil demand growth has deviated very little, ranging between 1-1.2 m b/d, with this year's growth expected to be very similar In contrast, the three years prior to that saw global oil demand growth from minus 1 mb/d to plus 3 m b/day,a range twenty times as large.

Meanwhile, the advent of US tight oil has made the oil market much less vulnerable to supply shocks than in the past.

Market and pricing dynamics in an environment in which a lack of OPEC action might result in a rising surplus are very different to a market that needs almost every drop of OPEC oil to prevent a shortage developing. Hence, the muted price reaction to the massive 3m b/d of OPEC outages prevailing currently.

The decline in implied volatility is also probably a reflection of changing dynamics in the crude oil options market itself. Demand for upside protection from consumers such as airline companies has dwindled, and hedge funds are much less interested in taking speculative positions in deep out-of-the-money upside calls. Meanwhile, with the futures curve in backwardation, oil companies are not keen to hedge price risk, margin hedging by refiners is less active and, due to increased regulation, the number of banks willing and able to warehouse oil price risk has also shrunk.

Looking ahead to the second half of the year, it is tempting to call for a potential increase in oil price volatility based on tighter fundamentals, including a sizeable increase in seasonal demand at a time when OECD inventories are unusually low, spare OPEC crude oil capacity will be shrinking and geopolitical risks remain high.

However, these factors are unlikely to result in anything more than a temporary move up in price volatility, in our view. The lesson of the past few years is that a return to high levels of implied volatility right along the oil curve is extremely unlikely unless there is either a sustained long-term threat to crude oil supply or another major dislocation to the global economy, neither of which we see as very likely any time soon.

The current risk/reward of being a seller of crude oil volatility may not be quite as attractive as it has been at times over the past few years, but any spike higher over the next few months looks like a selling opportunity, since we believe the factors that have driven the structural shift lower in oil price volatility are likely to persist for some time to come. Barclays report said.
Source: Barclays