Oil Markets in a Correction Below $100

​The media have been debating the reasons for the recent sharp decline in crude prices and profit taking  and a shift in positioning has been cited as the cause of the decline. While we will never truly know why the prices declined, it is entirely possible that profit taking one of the reasons behind the move, amonst other factors. 

​After a strong rally over the last three weeks, the oil markets are now in a correction and down to the 50% retracement level. These types of corrections are a normal part of price action, particularly when we see price overextending beyond three standard deviations. In those sitatuons, we are going to see a reversion to the mean, because we run out of buyers at the peak and we need a fresh impetus to keep the momentum going and there needs to be sellers to buy from. At these levels, the sellers are few and far between. We also see existing longs from lower down, starting to take their profits, and if large numbers run for the exits all at once, we get a sharp decline. 

However, the fundamentals don't change that quickly and the direction of travel has been set for the energy markets as the Ukraine war continues and sanctions start to take effect. So the fundamentals are clearly bullish for the forseaable future, but given the geo-politics affecting the energy markets right now, we are going to see a lot more volatility.
 
Increased volatility increases the risk for many traders and may actually trigger alerts in their risk management and position sizing models. This is another reason for why the longs head for the exit quickly. Lowering their risk exposure. So the path of least resistance is down, until the buyers come back into the market, looking to reposition and buy at a lower price. There are more sellers too as prcies decline beleiving that the top is in and the markets are turning south.

While the price action we've seen int he oil markets seems to have been quite extreme in recent weeks, it is not unusual in teh commodity markets. We get a speculative frenzy driven by the geo-politics news,  the market goes parabolic and over extends. At some point, typically beyond three standard deviations, the market will correct to restore equilibrium temporarily, reverting to the mean.

Replacing Russian Oil
 
The key fundamentals in the oil market are currently bullish but there is a great deal of uncertainty as a result of the situation with Russian oil. According to energy analysts, Russian oil flows can be replaced in the short term and the price implications of that displacement and substitution minimised by the extent to OPEC members increase output beyond current OPEC+ levels.

To avoid significant upside price pressure, energy analysts are estimating that the market would need an additonal flow of around 2 million barrels per day for the remainder of 2022 and an additioanl 2 million barrels per day in Q2 to ease the dislocations caused by the displacement of Russian oil. The temporary 2 million barrels per day boost could come from strategic reserves, but the 2 million barrels per day additional flow for the remainder of 2022 would likely need to come from OPEC sources (including potentially Iran).
 
It is absolutely clear from this, that we have a tight market situation, however, the  withdrawal from Russian markets has been less dramatic than expected across Europe. So far, there are indications that some of the larger EU countries are less keen than countries in the east of the EU to pursue the fastest possible reduction in Russian oil flows. Outside of the EU, the UK’s ban on the import of Russian oil has proved less dramatic than the headlines that accompanied the initial announcement, as it does not take effect until the end of 2022.

In the private sector, while several companies have given assurances they will buy no more Russian oil on the spot market, thereare limited indications to suggest how they will purchase oil from Russia through their term contracts. Reducing dependance is easier said than done and we've seen governments and companies opting for longer time frames for the process of reducing dependance. Indeed, energy analysts have observed that Russian oil trade into Europe appears to be moving further into the shadows of term contracts and a greater reliance on third-party trading intermediaries, which makes the trades less visible.