Omicron-driven Oil Slump Raises Risk of OPEC+ Action

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Published: Nov 29, 2021, 12:26 UTC

Crude oil suffered its largest one-day crash since April 2020 on Black Friday in response to worries the new omicron virus variant could drive renewed demand weakness at a time where the US and other major oil importing nations are about to unleash millions of barrels of crude oil into the market from strategic reserves.

Omicron-driven Oil Slump Raises Risk of OPEC+ Action

Crude oil suffered its largest one-day crash since April 2020 on Friday in response to worries the new omicron virus variant could drive renewed demand weakness at a time where the US is about to release millions of barrels of crude oil from its strategic reserves. While many have already concluded Friday’s slump was an overreaction caused by thin market liquidity, the focus is once again squarely on the response from OPEC+ who will meet on Thursday to set production levels for January and potentially beyond.

Equally importantly was probably the very bad timing with the news hitting the markets on a low liquidity day after the Thanksgiving holiday. Long held bullish conviction trades got stopped out as the sudden elevated level of risk aversion drove major position adjustments across most asset classes.

As volatility spiked, the options market also kicked into gear with hedging of short puts adding an additional layer of pressure with sell orders being executed at whatever price available. On Friday the 30-day historical volatility jumped from below 25% to 44% and it has ticked higher today, an indication of some unfinished business from Friday, but also a market which is struggling to settle down with Thursday’s OPEC+ decision adding an additional layer uncertainty.

So far today, the market is trading higher, but already off their overnight highs, but the reduction in hedge selling has allowed buyers to take a fresh look with some concluding the move on Friday was most likely an overreaction. Not least considering the prospect for support being provided by OPEC+ who may attempt to prop up prices when they meet this Thursday. The group may decide to postpone the January production increase or if necessary, temporary cut production into a period that was already expected to see the return of a balanced market.

Brent crude oil’s 11.6% top to bottom slump on Friday was only arrested when the price reached its 200-day moving average at $72.70 and after the price retraced 61.8% of the August to October surge. A key reason behind that run up in prices was driven by increased switching demand from record priced gas to cheaper oil-based fuels such as diesel, heating oil and propane. Following the drop in crude oil and continued strength in gas and power prices, the prospect for continued and rising switching activity will remain a key source of extra demand that did not exist during the 2020 slump.

Adding to crude oil’s current bid are forecasts from the world’s top commodity traders, all speaking at the FT’s Global Commodity Summit, that oil prices could return to $100 over the coming years as investment in new supplies slows down with oil majors diverting capex towards renewables instead of continued oil and gas production. It highlights a potential rising dilemma where politicians and investors want to move towards renewables at a much faster pace than actual changes can be made. Thereby creating the risk of a supply shortfall before demand eventually begins to slow towards the second half of this decade.

Brent crude oil has set its sight on the 2019 peak at $75.6 ahead of the downtrend (red line) from the 2008 peak. Some focus on today’s FOMC meeting which may yield a change in the interest rate outlook while the market seeks further clues about the Fed’s view on inflation, and with that the need for inflation hedges through long commodity exposure.