Opec+ is losing control of the oil market - UnHerd

Opec+ is losing control of the oil market - The Post

Opec+ is losing control of the oil market

Short sellers are artificially driving down the price of the commodity

Strange things are happening in the global oil markets. The prices, set by the oil futures market, seem to make less and less sense when compared to the underlying fundamentals. Last week, Opec+ convened a meeting at which the cartel decided to cut oil production by a total of 2.2 million barrels per day.

In normal times, this announcement would lead the price of oil to rise. After all, if the demand for a good remains unchanged and its supply decreases, basic economics would tell you that the price should rise. Not so in the oil market. After Opec+ announced its new round of production cuts, the price of oil fell from around $80 a barrel to around $74.

In response, market commentators for the most part tried to justify the decrease in price by claiming that the Opec+ production cut was not well “communicated”. But the market price for a commodity such as oil does not depend on the Opec+ public relations department — it rests on how much black liquid the cartel pumps out of the ground.

Another excuse doing the rounds was that the decrease in price was because the market did not trust Opec+ to follow through with the cuts. But this makes no sense: after the meeting there was a higher probability of greater cuts than beforehand. It is the difference between Opec+ agreeing to play a hand regardless of whether their cards are weak, or simply sitting this one out.

Gradually, smarter commentators began to suspect that something strange was going on. The day after the meeting, Bloomberg ran a column explaining how the oil market has been taken over by speculative traders and algorithmic trading. The algorithms sell oil when given specific signals, but speculative short sellers seem to have felt out the pain points at which the algorithms are activated. Now they are selling oil in huge volumes, which then triggers the algorithms, pushes prices down further and allows the speculators to profit on their large short positions. According to market research firm Bridgeton Research Group, such algorithmic bets have now reached record highs in the oil market.

Why does this matter? Although consumers benefit from cheaper oil, artificially suppressed prices have serious ramifications. If the current oil price is substantially lower than what it should be, then people will be encouraged to consume more oil. At some point, though, the supply will dwindle due to overconsumption and prices will snap back violently.

The futures market cannot pretend forever that there is more oil than there really is. In effect, it is writing contracts for barrels of oil that do not exist, thereby “printing oil”. This is completely unsustainable.

Politicians, however, could not be happier, especially Joe Biden. Among Americans, 67% disapprove of the President’s handling of the economy, and given that oil prices are a heavily politicised issue in the United States, Biden will be extremely happy with these developments. Some have speculated that his administration will use the opportunity to refill the Strategic Petroleum Reserve that it has recklessly sold off in an attempt to counteract rising energy costs.

But we cannot forget that it is Opec+ which controls the supply of oil, and the group stated clearly that it will be reducing this supply. Eventually, prices will go up again — and it is leaders like Biden who will face the consequences.

Biden might just need to ensure that the US pumps more oil. In fact, I think he has realised this already.

This article assumes OPEC members stick to their agreements.

The author is highlighting inefficient pricing. The consequences of natural price discovery, when it happens, will be painful for consumers.

The global financial crash showed governments and markets are willing not just to ignore but to encourage and perpetuate inefficient pricing (in that case, debt) if it suits them. The result then was a banking collapse that the rest of us continue to pay for.

An artificially falling oil price offers Western governments short term relief. The inevitable huge spike in oil price later on will help the viability of the very many poor net zero investments governments and investors have made on our behalf. Such a spike would benefit oil producers and market makers too.

Thus the stage is set for governments and markets everywhere to do everything in their power to encourage and perpetuate the inefficient pricing of oil for as long as possible. The result will be a huge bill paid by the rest of us.

I’ve just looked at some historic oil price charts and there is nothing there that suggests that oil is under-priced or at any sort of historic low.

They also remind you that commodity prices are volatile. Always have been. Always will be. Those of us who have to buy home heating oil are very familiar with this. You just have to live with it.

I’m not sure what’s “wrong” with any of this. If short sellers are exploiting the market, it is because there is inefficient pricing. Philip Pilkington admits this is the case – the algorithmic trading programs have flaws (he says). If so, then the action of the short sellers will correct the mis-pricing and eventually these algorithms will improve and the speculative opportunity dry up (much the same as companies like Hanson Trust in the 1980s only existed because there were inefficiently run public companies to restructure). In what way is that not normal or expected ?

Speculators are a necessary evil of efficient markets – they provide the liquidity and trading volume to ensure efficient pricing.

The US is a net oil producer – and obviously not in Opec (or Opec+ whatever that is). It also has large unused reserves. If it chooses to allow Opec to affect oil prices, that is a choice rather than a hard fact.

It’s decades since Opec had a decisive effect on oil markets – largely because there is ultimately little common ground between its members.

I’m not sure the author is saying it is wrong, only that it is inefficient pricing and the consequences of natural price discovery will be painful for consumers. My concern is the efficiency of the oil market to facilitate natural price discovery. The great financial crash proved many markets (e.g., mortgage debt) are captured by relatively few big brokers who, motivated by goverment and regulators, can suppress natural price discovery for years if it suits everyone involved.

But I’m not sure his claim that oil prices are artificially suppressed (low) is correct. If that were true, then prices must earlier have been mis-priced high (by the trading algos). In which case the correction has a temporary overshoot. Which is probably expected.

Not convinced by your explanation for the 2007 financial crash either. That was primarly a problem of poor regulation and fake credit ratings (ratings agencies, not brokers).