Analysis

Another Asset Falls Victim to COVID-19 Liquidity Issues – Oil

The oil markets have seen much wider spreads than usual, due to oil tensions and COVID-19.

As the coronavirus pandemic continues to cause huge volatility, liquidity issues have arrived. South Korea has been struggling with United States dollar liquidity, gold has also been hit, and more recently, oil has also come under fire.

As Finance Magnates previously analyzed, the huge volatility has been largely beneficial for brokers, as client activity has increased, but at the same time, it has also caused challenges surrounding oil.

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Oil markets experience wider spreads

Namely, the coronavirus pandemic has brought the global economy almost to a standstill. Since the pandemic set in, oil prices have dropped by almost half. At the beginning of the year in January, as the threat of COVID-19 continued to build, oil prices began to drop, as demand expectations fell.

Recently, the oil markets have seen much wider spreads than usual, which has lead to liquidity providers increasing their swap charges in response to the forward curve currently being observed in the underlying market.

Andy Biggs of CFH Clearing
Andy Biggs, Head of Liquidity at CFH

Speaking to Finance Magnates, Andy Biggs, Head of Liquidity at CFH, explained: “CFH’s rolling spot oil product updates swaps on a daily basis in accordance with the interbank market. Oil spreads are naturally wider given the huge volatility and more generally we’re seeing less liquidity available at depth and the behaviour of that liquidity mirror much less liquid commodity contracts.”

There are two main factors that have been influencing oil. Firstly, the oil price war between Saudi Arabia and Russia has significantly impacted the price of the commodity. This has seen Saudi Arabia significantly increase production in oil, tipping the balance between supply and demand and driving down the price. Secondly, COVID-19 has also heavily impacted demand. Therefore, the price of oil has gone from being traded at US$50down to US$20. 

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“The latest high impact event saw a Trump tweet suggesting Saudi Arabia and Russia would agree to limit production by 10 million barrels,  roughly a 10th of global supply, cause a huge spike in pricing,” Biggs highlighted.

Not a classic liquidity issue

However, as pointed out by Chris Nelson-Smith, the Head of Risk at Vantage FX, what we are currently seeing with oil isn’t a liquidity issue in the classic sense: “Usually liquidity becomes an issue when there is an acute shortage and it is drying up. In this case there is a huge oversupply given the expected demand in the near future. Both WTI and Brent Oil prices have fallen by more than half this year; the sort of agreement required from the largest players to support oil prices would mean the deepest production cuts in history.

“Certainly the largest producer of oil, the US, would need to be involved and recent rhetoric from Trump regarding US participation in said talks led to the violent swings in the market in the last few sessions.”

So how long can we expect these liquidity issues to remain? According to Nelson-Smith, the answer to that is unclear: “I have no doubt an agreement to reduce production will be done in the near future, but whether or not that will be enough to support oil prices in the face of the immediate glut of supply is questionable,” he said.

“Until the global economy has a true idea of the expected timeline of a return to normality in the worlds biggest economies we will continue to see disruption in the energy markets.”

In the wake of these issues, Vantage FX has adjusted its spread filters and maximum spread settings, to ensure that pricing is available for all of its markets and customers.

 

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