(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON Dec 8 Like a rabbit trapped in the
headlights of an oncoming car, Brent prices have remained static
in the past fortnight despite an exceptionally heavy news flow.
The market has been hit by a series of large shocks ranging
from the deepening debt crisis in Europe to possible sanctions
on Iran's exports and speculation about a military strike on the
country's nuclear facilities.
News that would normally have a significant impact has had
none at all, however. Instead the market is paralysed by
informational and analytical overload, unable to process the
unusually large number of economic and political risks. "Forward
visibility" has shrunk from the usual months to just weeks or
Daily price movements have been unusually small. Realised
volatility has fallen to 22.6 percent over the last 30 trading
days, down from more than 35 percent in October, putting it in
the 23rd percentile of the 2006-2011 distribution, and the trend
is still lower.
Front-month Brent futures prices have ranged less than 2.25
percent a day in the last fortnight compared with an average of
more than 3 percent since the start of 2006.
The market's steadiness in the face of a string of
larger-than-usual shocks has several causes:
(1) Seasonal factors. Risk appetite is traditionally low at
this time of year as traders and hedge funds square up positions
ahead of the year-end and the final calculation of profits,
losses and bonuses.
(2) Balance of risks. Bullish influences on oil prices
(escalating tensions in the Middle East) are matched by large
offsetting risks on the downside (worsening economic slowdown in
Europe now spreading to emerging markets).
(3) Multiple uncertainties. The number of potential major
price-drivers has multiplied so much and the range of
uncertainty surrounding them has grown so wide that it has
become impossible to forecast more than a month or two ahead
with any degree of confidence.
Markets are complex social and financial systems
characterised by strong non-linearity. They thrive on
differences of opinion, which is what provides liquidity and the
incentive to trade.
But most market participants prefer simple narratives and
want to focus on a relatively limited range of risks that
polarise around just two or three scenarios. The repeated
inflation/deflation debates in 2009-2011 are a good example of
polarising but fairly simple narratives that generated
significant trading activity and volumes. The risk on-risk off
debates earlier in 2011 are another.
Markets prefer a carefully controlled amount of uncertainty.
Too much uncertainty, and everyone moves to the sidelines.
EUROPE, IRAN AND USUAL RISKS
At the moment, there are simply too many major factors in
play to organise the outlook into a small number of well-defined
scenarios or narratives. Tremendous uncertainty about any one of
those factors swamps the entire forecast outlook.
If Europe slides into recession as a result of the deepening
debt crisis and takes the United States and emerging markets
with it, the resulting drop in oil consumption would easily
swamp forecasts about growth in non-OPEC supply and the
resumption of Libya's exports.
Equally, if escalating tensions in the Middle East cannot be
controlled, they have the potential to trigger the largest
disruption in oil supplies for more than a decade.
On a smaller scale, the market is coping with more
run-of-the-mill uncertainties: the speed of Libya's output
recovery; production problems in the North Sea and erratic
growth in non-OPEC supply; the cartel's unclear production
policy; and a rapidly changing long-term outlook as a result of
tight oil from the North Dakota's Bakken formation and
While analysts are unable to predict the outcome of any one
of these risk factors with any confidence, it is impossible to
produce a credible forecast. The only attractive strategy is one
that keeps all options open.
In normal times, market participants can subsume the wide
range of uncertainties into a simple over-arching narrative.
During 2005-2008, that was concerns about peaking oil production
and burgeoning emerging market demand. In 2009-2011, it was the
pace of recovery in the advanced economies and continued growth
in developing countries.
These are oversimplifications. Most market participants
willingly fool themselves about the predictability of the future
and underestimate the degree of uncertainty and variability in
the outlook. But such simplifications are needed to give
participants the confidence to trade and take risk.
In the current environment, the sheer range and scale of
uncertainties defies easy categorisation and has shattered any
illusion of predictability. There is no dominant narrative.
As a result, many participants are on the sidelines, waiting
until some of those uncertainties resolve themselves before
taking more risk.
(editing by Jane Baird)