Could we see dramatically higher implied volatility in crude oil options in the coming months? In Q2 2025, OPEC+ will have to revisit its production cuts, which have taken 3.5 million barrels of oil per day off the market, costing them market share (Figure 1). This decision will come amid relatively weak demand resulting from an accelerating revolution in automotive technology, soft economic growth in China and increasing supply from the U.S.
In the mid-1980s and mid-2010s when OPEC opted for increased output, oil prices fell by 67-75%. It’s not clear that increasing production by perhaps one million to three million barrels per day could have such a dramatic impact on prices this time around, but the potential for volatility, and in particular downside price moves, may be elevated. Moreover, the scale of price declines that followed production increases in the mid-1980s and mid-2010 might lead OPEC to conclude that increased market share isn’t worth the potential drop in the price of oil.
Low Implied Volatility and Neutral Skew Ahead of a Major Decision Point
As of late February, CME’s CVOL on WTI – a comprehensive measure of implied volatility – was near historic lows, suggesting that any increase in volatility may come as a surprise to many traders who have grown accustomed to a rangebound market (Figure 2). Moreover, the skew of volatility – implied volatility across different strike prices – has been relatively neutral, suggesting that out-of-the-money put options are not particularly expensive relative to out-of-the-money call options.
The Accelerating Automotive Revolution
Over the past half century there has been a revolution in automotive technology which has ongoing implications for the prices of crude oil and its refined products. Since the Environmental Protection Agency (EPA) began collecting data in 1975, the average car has increased in weight by 8%, nearly doubled in horsepower while consuming less than half as much fuel per unit of distance driven (Figure 4).
The initial phase of this revolution was very much driven by the twin oil crises of 1973 and 1979 which sent oil prices from $3 per barrel to $12, and then $40 (Figure 5). From 1975 until the early 1980s, cars became more fuel efficient largely for two reasons: they had smaller, less powerful motors, and they weighed less as consumers transitioned from heavier models to compact cars.
During the 1980s and 1990s, the trend changed again with the average weight slowly increasing as more consumers opted for minivans and later to SUVs with more powerful motors. Much of this trend was driven by a mid-1980s drop in oil prices from $33 per barrel to as low as $12. Oil prices generally stayed low until the late 1990s, when they again crossed above $30 per barrel.
Starting in model year 2005, a second technological revolution began. Vehicles continued to gain in horsepower and weight while fuel efficiency improved dramatically. Comparing model year 2024 to model year 2004, the average car sold in the U.S. consumed 31% less fuel per unit of distance driven than 20 years earlier.
Given that the average car has a lifespan of about 12 years, this equates to a 2.5% annual reduction in fuel consumed per mile (or kilometer) driven. In other words, just to keep demand stable, collectively we would need to drive roughly 2.5% more each year.
EVs are part of the story. In the U.S., plug-in EVs have gone from less than 0.1% of cars sold in 2010 to 11.4% by 2024. Hybrids of various sorts have gone from 4% to 18% of the U.S. market while traditional gasoline engines have now been largely replaced with gasoline stop-start models that don’t idle while stuck in traffic (Figure 6).
In China, EV sales surged from 35% of new cars sold in 2023 to over 50% in 2024. If China consumes 15% of the world’s crude oil and about 1/3 of this oil is used to power cars, and the average car lasts for 12 years, replacing 50% of the retiring cars in China each year with EVs could reduce global consumption of crude oil by about 0.3%, adding to the global demand headwinds for crude oil and its refined products.
Moreover, during the pandemic, more and more people discovered the possibilities of working from home and shopping online. In the U.S., for example, data from the Federal Highway Administration suggest that Americans are driving only slightly farther in 2024 than they were in 2019.
How the Pace of Growth in China Influences Oil Prices
After the year 2000 there was another big shock to the oil market that prompted the current round of innovation. This time it wasn’t a supply shock like in the 1970s but rather a demand shock in the form of China.
China went from being a net oil exporter in the 1980s and early 1990s to being the world’s largest importer of oil, consuming about 15% of global production, of which two thirds was imported (Figure 8). As China and other emerging economies began to import more oil, the price of crude soared from an average of $20-$30 per barrel during the 1980s and 1990s to around $80 per barrel from 2007 to currently, although the range during that period was from the $20s to as high as $147.
After 2005, oil prices rose and fell, lagging variations in the pace of Chinese growth by about one year. When Chinese growth peaked in 2007, 2010, 2017 and 2021, oil prices tended to peak about one year later in 2008, 2011, 2018 and 2022 (Figure 9).
The Role of U.S. Supply
Meanwhile, increased U.S. production has replaced roughly half of what OPEC removed from the market (Figure 10). All of this puts OPEC+ in a dilemma. Do they increase production, allowing prices to fall in the hopes of regaining market share as they did in the mid-1980s, mid-2010s and in early 2020? Or do they maintain production cuts and risk subsidizing U.S. producers and incentivizing a further move away from oil in the automotive industry?
How OPEC+ responds to its changing environment could go a long way to determining whether prices stay in the current range and if implied volatility on crude oil options remains at its current level, which is near the lower end of its historic range.
Source: CME Group
