Oil Markets Are Volatile But They’re Not Broken

Oil markets are broken. Extreme volatility and a lack of liquidity mean that crude futures have become disconnected from tight physical oil markets. At least that’s what some loud voices in the oil world are telling us. But I suspect they may be talking their own books.

Complaining that markets are broken suggests to me that somebody has traded on the wrong side of the recent tumble in oil prices, positioning for a rise that hasn’t happened.

Assertions that futures and physical markets have become disconnected aren’t new. They’ve been around for decades. When oil prices were soaring in 2007-2008, oil ministers from members of the Organization of Petroleum Exporting Countries lined up to moan that futures markets had gotten too big. The volume of oil being traded, often by people who had no intention of ever handling a single barrel of the black stuff, was many times larger than global trade in physical crude. These “speculators” were driving the price of oil to record highs, while physical supplies, producers said, were ample.

Now we’re being told the opposite by Saudi Arabia’s Energy Minister Abdulaziz bin Salman and others. There aren’t enough people trading in oil futures, and the paper market, as it’s known, isn’t reflecting the true tightness of crude supplies. This time it’s not the fault of the speculators, but too few producers seeking to hedge the value of their future production by buying futures.