Standard Chartered Blames Gamma Hedging For Overdue Oil Selloff
The energy sector has emerged as the worst performer among all 11 sectors of the U.S. market in the current week, with energy prices dropping sharply as a spate of bank failures reignited a wave of risk-off selling.
Oil prices have crashed spectacularly, with WTI crude falling from $80.46 per barrel just 10 days ago to the $67 range, while Brent has declined from $86.18 per barrel to the $73 range, levels they last touched in December 2021. On Friday, things improved slightly, with Brent moving into the $75 range and WTI testing $69.
Commodity analysts at Standard Chartered warn that the oil price crash has been exacerbated by hedging activity–specifically, due to gamma hedging effects, with banks selling oil to manage their side of options as prices fall through the strike prices of oil producer put options and volatility increases. The negative price effect has been exacerbated because the main cliff-face of producer puts currently occupies a narrow price range.
While gamma hedging effects did not cause the initial price fall, they have caused a short-term undershoot, further magnified by the closing out of associated less committed speculative longs. StanChart has worked out the distribution of producer puts based on a survey of 46 U.S. independent producers.
On a brighter note, StanChart’s proprietary bull-bear index rose 32.2 w/w to a mildly bullish +20.1, buoyed by declines in crude inventories (both nationally and at Cushing) relative to the five-year average as well as improvement in demand. The analysts have predicted that oil prices will recover as the global oil surplus dissipates.
Source: Standard Chartered
A cross-section of commodity experts are saying that the oil price crash is an overreaction to the banking crisis and that the selloff is overdone. Michael Tran, managing director of global energy strategy at RBC Capital Markets, has told Bloomberg that the oil markets are reacting as if the economy is in a full-blown recession, “This is a (oil) market effectively trading as if the economy is already in a full blown recession. Everybody knows why oil prices are coming off. It’s not an oil market specific issue, it’s a broad macro issue,” he has stated.
Tran sees oil prices climbing in the second half of this year amid China's economic reopening, and heightened demand coming from India. He also anticipates that oil prices will climb in the coming weeks and months once the panic settles within the markets.
The good news at this juncture is that most experts believe that the banking crisis is not systemic nor indicative of a looming financial crisis.
Whereas the U.S. government has ruled out a bailout for SVB, its Swiss peer has been more lucky after the troubled lender was offered a lifeline after the Swiss National Bank agreed to loan the struggling lender up to 50B francs ($54B). The bank also announced public tender offers by Credit Suisse International to repurchase certain OpCo senior debt securities for cash of up to ~3B francs. Previously, the Saudi National Bank, which owns almost 10% of Credit Suisse, declared that it would not provide further support to the group, days after the bank disclosed ‘material weakness’ in its financial statements just weeks after reporting a net loss of £6.6 billion for FY 2022.
As a Global Systemically Important Bank, the plight of Credit Suisse has been a much bigger concern for the global markets due to the sheer scale of its balance sheet and much bigger potential for contagion from the bank’s global reach. But the fact that shares of Credit Suisse and those of European banks have recovered swiftly suggests that the markets do not view the banking crisis as being systemic or likely to unravel on a wider scale. As UBS Wealth chief investment officer Mark Haefele has said, the swift action by the FDIC to guarantee deposits and by the Fed to lend to banks that require funds will solve liquidity-related risks for U.S. banks and also for the U.S. branches of foreign banks.
The broader market is also in a bullish mood.
For the third straight week, investors have been net buyers of fund assets including exchange traded funds (ETFs) and traditional funds. For the seven-day period ending March 15, market participants pumped $88.4B of net capital into the fund market with money market funds taking in $108B. Interestingly, the SPDR S&P Regional Banking ETF (NYSEARCA:KRE) attracted the most significant cash at $1.4B, while SPDR Gold Trust (NYSEARCA:GLD) came in second after pulling in $501M.