Saudi prince says oil disconnect may force OPEC+ action

(Bloomberg) —

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Saudi Energy Minister Prince Abdulaziz bin Salman said “extreme” volatility and a lack of liquidity meant the futures market was increasingly disconnected from fundamentals and OPEC+ could be forced to cut output.

“The markets for paper and physical products are becoming increasingly disconnected,” he said in response to written questions from Bloomberg News.

Prince Abdulaziz represents the largest oil producer in OPEC+ and is arguably the most important player in the 23-nation alliance. He said futures prices did not reflect fundamentals of supply and demand, which may require the group to cut output when it meets next month to review production targets.

“Finding that this recent damaging volatility is disrupting essential market functions and undermining the stability of oil markets will strengthen our resolve,” he said.

Benchmark crude oil futures have fallen more than 20% since early June on concern about the outlook for the global economy and the possibility of more Iranian oil hitting the market. Brent futures pared losses after the prince’s comments to trade near $96 a barrel, having earlier sunk to nearly $92.

However, open interest and trading volumes remain well below historical levels as price volatility caused by the war in Ukraine spooks investors. The lack of trading makes the market more volatile as the pool of active buyers and sellers shrinks, according to some market participants.

Saudi Arabia and the rest of the OPEC+ group have steadily increased output this year, reversing all cuts made during the coronavirus pandemic as demand rebounded and Russian supply fell.

Here is a transcript of Prince Abdulaziz’s responses to written questions:

Worried about the current state of the market?

The paper oil market has fallen into a self-perpetuating vicious cycle of thin liquidity and extreme volatility, undermining the market’s essential function of effective price discovery and making hedging and risk management costs prohibitive for physical users.

This has a negative impact on the smooth and efficient functioning of oil, energy commodity and other commodity markets by creating new types of risks and uncertainties.

This vicious cycle is reinforced by the flow of unsubstantiated stories about the destruction of demand, the repeated news of the return of large volumes of supply, and the ambiguity and uncertainty about the possible effects of price caps, embargoes and sanctions.

In your view, how is the current volatility affecting the functioning of the markets?

This is detrimental because without sufficient liquidity, markets cannot meaningfully reflect the reality of physical fundamentals and can provide a false sense of security in times when excess capacity is very limited and the risk of severe disruptions remains high.

Nowadays, one doesn’t have to look far for evidence of this. Markets for paper and physical products are increasingly disconnected. In a way, the market is in a state of schizophrenia and this creates a type of yo-yo market and sends wrong messages at times when more visibility and clarity and orderly markets are needed to allow market participants to effectively hedge and manage huge risks and uncertainties they face.

Should OPEC+ respond?

In OPEC+ we experienced a much more difficult environment in the past and we have emerged stronger and more coherent than ever. OPEC+ has the commitment, flexibility and means in the existing mechanisms of the Declaration of Cooperation to address such challenges and provide guidance, including cutting production at any time and in different forms, as has been clearly and repeatedly demonstrated in 2020 and in 2021.

We will soon start working on a new agreement after 2022, which will build on our past experiences, achievements and successes. We are determined to make the new agreement more effective than before. Observing this recent damaging volatility disrupting basic market functions and undermining the stability of oil markets will strengthen our resolve.

(Updates the values ​​in the fifth paragraph.)

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