Trade wars aren’t much fun, but the world was reminded over the weekend that a real war—or the specter of one—is even worse.
The threat of an expanded global military conflict intensified Saturday when drones attacked critical oil production and distribution facilities in Saudi Arabia were attacked by drones.
The havoc wreaked on assets owned by the state-owned Saudi Arabian energy company known as Aramco is believed to have affected roughly 5.7 million barrels per day, or nearly 5% of total daily global production.
Cutting out that much supply would have a dramatic effect on any market, but one could argue that with the Organization of Petroleum Exporting Countries (OPEC) already throttling production (through a coordinated supply cut) the impact on the crude oil supply chain could be exponentially greater.
Financial markets appeared to confirm this concern Monday when trading opened in energy markets. At that time, two of the world’s most widely followed benchmarks for crude oil made some of the biggest single-day moves on record.
For Brent crude, traded out of London, the spike was the highest observed in 30 years, moving the price up nearly 20% to close at $69.02 per barrel. For West Texas Intermediate (WTI), which is the highest-volume crude oil contract traded in the U.S., the price bounced roughly 15%, which was its biggest move since 2008. WTI futures closed trading Monday at a price of $62.90 per barrel.
Adding further context to the intensity of the moves, consider the fact that the OVX (CBOE Crude Oil Volatility Index) was up about 40% on Monday, and was trading at levels not seen since December of 2018, which was when the bottom was falling out of the crude oil market.
While volatility gauges like the OVX and VIX typically trade in inverse fashion as compared to the direction of the underlyings they are associated with, there are special circumstances in which they do sometimes move in the same direction. This was the case Monday when both crude oil prices and the OVX moved significantly higher.
As a brief reminder, the reason that oil prices and the OVX (or the S&P 500 and VIX) are usually inversely correlated ties back to the fact that the price of the OVX is calculated using the implied volatility of crude oil options. And implied volatility usually rises when crude oil is dropping.
Monday helped illustrate that implied volatility can also spike when a huge unexpected move occurs to the upside.
The context of this historic day in the oil market becomes even more intriguing when one considers that Iran is the subject of an international oil boycott. And that the Iranian-backed Houthi militia currently operating in Yemen claimed responsibility for the attack.
Saudi Arabia and Iran are currently fighting a proxy war in Yemen through warring militias which has forced millions of Yemeni civilians into desperate living conditions. As if all that wasn’t enough, participants in the global crude oil supply chain were already on edge due to recent attacks on oil tankers traveling through the Persian Gulf and the Strait of Hormuz.
While the immediate focus shifts to repair work on Saudi oil infrastructure, traders and investors in the energy niche of the international financial markets will certainly be left wondering what might come next.
If the masterminds behind the tanker attacks, and the recent drone attacks in Saudi Arabia, are one and the same, then it’s entirely possible another terrorist operation could be deployed in the near future.
Some might recall that when crude oil spiked roughly 20% during the Libyan civil war in 2011, the S&P 500 lost 5% of its value. The global economy is closely tied to the price of crude oil, and when prices go up significantly, the added cost of energy can often represent a headwind to global economic growth.
With the U.S.-China trade war already putting stress on global trade and growth, any exacerbation of the situation (due to skyrocketing oil prices or even outright war) would likely put international asset prices under pressure.
In that regard, traders and investors should closely follow developments in the Middle East, not only for potential trading opportunities but also as a potential signal to tighten risk controls in their portfolios.
As of Tuesday, the Saudi government indicated their full production capabilities could be restored as soon as early October. However, that assessment is anchored upon the assumption that no further disruptions materialize in the interim. To learn more about the OVX, a previous installment of Market Measures on the tastytrade financial network is recommended.
Sage Anderson is a pseudonym. The contributor has an extensive background in trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of luckbox, tastytrade or any affiliated companies. Readers can direct questions about topics covered in this blog post, or any other trading-related subject, to email@example.com.