Oil price-volatility shift gauges geopolitical risk
Uncertainty in Syria and fears of a full-scale Israel-Iran war are likely driving new dynamic
The implied volatility of oil futures typically rises as the oil price falls (because there is more demand for hedging on the part of producers). That is the relationship we observe from January to December in 2017, as shown in the scatter graph.
From December 2017 through April 2018, though, we observe a 90-degree shift in the relationship. Oil futures volatility rose as the oil price rose. That suggests a different dynamic in the oil market, and the likeliest conjecture is that both prices and volatility were to some extent driven by geopolitical risk.
As the United States prepares to leave Syria, US officials, including Defense Secretary James Mattis, have speculated about a possible military confrontation between Israel and Iran. This still remains a remote probability, because none of the participants want a war any time soon. Some Israeli security analysts have suggested that a big war with Iran might be preferable to a war of attrition against Israel conducted by Iranian proxies in Lebanon and Syria, but that is more of a threat than a forecast.
In the event of an Israel-Iran war oil prices would jump to a much higher level. The risk premium on oil prices in today’s market probably is no more than a few dollars per barrel, but it does appear to have influenced the implied volatility of oil futures.