There are different kinds of oil price movements. The first case, which today is only of historical interest, arises when oil prices in international trade were administered first by a group of major oil companies and subsequently by OPEC. The oil price behaviour followed then a typical pattern characterised by periods of different lengths during which a reference price (eg Arabian Light 34 API) remained constant in nominal dollars. We had therefore price episodes, and the passage from one episode to the other was the result of a punctual decision by the entity which happened at the time to administer the price of oil. We had then occasional price shocks rather than continuous volatility. The fundamental difference is in the nature of the adjustment process that shocks and volatility induce.
The second case describes a price regime that was introduced in 1987 and that is still ruling today. OPEC no longer fixes the reference price. The exporting countries now sell oil in international markets on the basis of price formulae which use as reference the spot or futures prices of certain marker crudes, namely WTI, Brent or Dubai.
The behaviour of prices in the world petroleum market is essentially that of these marker crudes. Volatility therefore arises in the complex and interrelated set of spot, futures and other derivatives markets.
Volatility is simply a characterisation of price changes over time. In futures markets the changes are almost continuous. They occur both within and between trading days. Prices change in responses to ‘news’ – that is to a very wide variety of information data which influence traders’ views on whether it is opportune to buy or sell. If the news, for example, are bullish some will want to buy and they will raise the bid price to the level that will persuade others to sell.
Relevant news do not exclusively relate to the exact state of the supply/demand balance which in any case is generally unknown. Traders also respond to news that alter perceptions of future market developments such as policy statements, economic forecast, industrial events etc. As important are the information that a trader may gather or the guesses s(he) may make about the positions taken by other traders and their trading optimization strategies.
Trading requires volatility. Without it there will be no need to hedge and where there are no hedgers, there are no brokers . But trading can also cause additional volatility; additional here refers to price changes brought about by strategies which are not determined by responses to perceived changes in current or future fundamentals but by the search for pure trading profits.