Oil Prices: Will the Risk Premium Evaporate?

Oil prices and broader market diverged

On May 21, US crude oil July futures fell 0.1% and settled at $63.13 per barrel despite a 0.8% gain in the S&P 500 Index (SPY). Based on the API’s data on May 21, US crude oil supplies rose by 2.4 MMbbls (million barrels) in the week ending May 17. The rise might be behind the divergence between oil and the broader market.

Oil Prices: Will the Risk Premium Evaporate?

Will the risk premium evaporate?

In the trailing week, US crude oil active futures have risen 1.9%. Although the rising diplomatic rift between Saudi Arabia and Iran contributed to oil’s rise, the risk premium might evaporate soon. The rising geopolitical tension might divide OPEC—a bearish development for oil prices.

The market seems to have ignored the war-like situation in the Middle East. On May 13, US crude oil’s implied volatility rose 6.5% after the news of an attack on oil tankers. Since then, US crude oil’s implied volatility has fallen ~20%. Even after President Trump warned Iran earlier this week, the implied volatility declined. The decline could indicate that market participants don’t expect any sharp movement in oil prices. Trade war tensions and rising US crude oil supplies could be more important factors for oil prices. Opposite to the API data showing a buildup in oil inventories, a Reuters poll suggests a fall of ~0.6 million barrels in the EIA inventory data for the week ending May 17. The data are scheduled to be released on May 22.