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What is average risk premium in oil prices?

Oil&Gas Materials 31 October 2019 17:51

BAKU, Azerbaijan, Oct.31

By Leman Zeynalova - Trend:

Risk premium in oil prices is currently negative, owing to concerns about global growth and trade tensions, and it is likely to remain low in the near term, Trend reports citing Capital Economics, UK-based research and consulting company.

The company says that in the context of the oil market, risk is often associated with geopolitics (and supply) not least because much of the world’s oil is produced in countries with either unstable political regimes or fraught bilateral or international relations.

Currently, the level of geopolitical risk is relatively high and has been on an upwards trend since the election of Donald Trump to the US Presidency, the company believes.

“The expected price of Brent should have hovered around $50-$65 per barrel between January 2017 and May 2019. After May 2019, weaker output from countries such as Iran and Venezuela, should have lifted oil prices to $75 per barrel. However, trade tensions and fears about economic growth weighed on the price, so that actual prices fell from $65 in May 2019 to $60 a few months later. We see the difference between the actual price and fundamental price of oil as the risk premium,” said Capital Economics.

According to the company’s model, the average risk premium in oil prices since January 2017 is around $6.40 per barrel, far higher than at the start of 2017 ($3.20).

“Looking ahead to 2020, we suspect that the market will be close to balance by the end of the year. Beyond 2020, we think that the risk premium for oil prices may remain low for two key reasons. First, the oil market should remain in a surplus or close to balance for some time. Second, global crude stocks are currently very high and could rise further in the years ahead if the market continues to be in a surplus,” said the company.

Capital Economics calculated the risk premium in oil prices by estimating the difference between what prices were and what they would otherwise have been based solely on supply/demand fundamentals.

“Currently, the risk premium is negative, and we expect oil prices to incorporate a risk discount for the remainder of this year. However, next year, we think that the risk discount will fade as investors’ worst fears about weak demand do not materialise. Looking even further ahead, we think that the risk premium may remain low because the oil market should be in, or close to, a surplus. That said, geopolitical risk, by its very nature, is unpredictable and the return of higher risk price premia cannot be ruled out.”

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