General Market Thoughts - Return of the Risk PremiumGeneral thoughts.
Whenever a price trend reverses quickly, it comes with a feeling it won’t last.
Maybe it was just a short squeeze, or FOMO etc………something that won’t last, and the prior price trend will continue soon enough.
The wise reaction in such circumstances is to sell the rally, and buy back when the price falls back.
The exception is when something has changed – ie a positive material change has occurred.
I think a paradigm may of shifted in a positive direction.
That paradigm is the risk premium in oil.
Iran’s April aerial attack on Israel was stopped in its tracks by Israel’s air defenses. This removed the risk premium from Oil. After all, if Iran’s missiles couldn’t touch Israel, then the risk of an Israel related escalation affecting oil supplies was minimal.
Iran’s attack was on April 14. WTI was about US$85.
By the end of April, WTI was in the high 70’s. The risk premium was largely gone.
In the weeks/months that followed, WTI fell to the mid $60’s. Various reasons were suggested – from Chinese economic disappointment; to release of OPEC spare capacity; and related financial speculation. These reasons may or may not be true. Aside from all those uncertainties, one thing was certain – the risk premium was close to zero.
Then on Sept 30, Iran tried again. It wasn’t a surprise. News media reported the attack at least 2 hours before launch. Israel and its allies were warned, and ready.
This time Iran used 180-200 Ballistic Missiles. This time many got through Israel’s air defenses. They may not of done much physical damage – but they established Israel couldn’t stop them. Yes some were intercepted, but enough got through. Enough to risk retaliation by Israel. Retaliation that may lead to escalation. Escalation that may impact oil supplies.
Today is Oct 4. WTI’s price has increased from the mid $60’s to the mid 70’s. Nothing has changed economically. Much of this rise may be short covering.
But now the risk premium is back.
Israel will respond. This response may or may not involve damage to Iranian oil supplies.
Instinctively I thought once this retaliation was over, the oil price would return back to where it was before.
And it may do. But now there is a risk premium to add to that prior price.
Israel will respond in some way. Iran will respond back. This pattern has been established. It’s a pattern of escalation. We don’t know where it leads. But we do know there is a risk that wasn’t there before. A risk that is likely to remain until this back and forth pattern resolves. This risk, is the Oil price risk premium.
If the risk premium is about $10, then a $65 dollar oil price may now be $75 ish.
If the risk premium has returned – then the zero risk premium oil price paradigm has changed.
If that paradigm has changed, then oil is unlikely to return to the mid $60’s after Israel’s response.
If oil doesn’t go back down, then the share price of high beta oil companies like OBE is unlikely to drop either.
Those are my thoughts – do with them as you wish.