Oil Market Liquidity Dries Up as Traders Sit Out War Volatility

ubq(1l4v)m9642{j]ab78g6v_media_dl_1.png Bloomberg, ICE

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(Bloomberg) — Oil market liquidity has evaporated since the start of the US-Iran war, amplifying price moves in a benchmark seen as a bellwether for the global economy.

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Total Brent futures open interest, a proxy for money in the market, plunged to the lowest level since August as traders increasingly shy away from the volatility tied to the Middle East conflict. The shrinking participation comes as the longest blockade of the Strait of Hormuz on record cuts off hundreds of millions of barrels of Persian Gulf oil from global markets, sparking an energy crisis. 

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“It’s so uncertain and the outcomes are so binary that people just retreat from the market,” said Aldo Spanjer, head of energy strategy at BNP Paribas SA. He presents a hypothetical scenario involving a trader who doesn’t believe a peace deal is imminent and is betting on higher prices. 

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This week’s “headlines would have stopped you out, even though you might be right about direction,” he said. “And that’s happened five times now. It’s close to untradeable.”

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Brent futures’ nearly 12% plunge on Wednesday, triggered by news of a potential breakthrough, reignited a familiar ache for oil investors, who have had to navigate a string of potential deals that ultimately failed to materialize since the conflict began in early March. Shifting prospects for peace and a constantly changing tone from the White House at one point pushed second month options volatility to its highest level on record. The gauge has since eased, though it remains elevated.

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Such outsized price swings are a hallmark of thin liquidity. They’re also a reminder to traders — many of whom were forced out of positions by a similarly abrupt price move earlier in the war — of just how punishing the market can be.

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The remaining participants are largely made up of algorithmic traders, oil producers, highly speculative macro hedge funds and likely some fundamental players with risk sharply dialed down, according to Rebecca Babin, senior energy trader at CIBC Private Wealth Group. 

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Others are favoring trades involving time spreads, relative value across crude grades, and delta hedging from options books, as opposed to more straightforward bets on flat price, she added. 

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“I’m calling it a risk-taking desert,” said Scott Shelton, an energy specialist at TP ICAP Group Plc. “There’s really only people hedging.”

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