July 5, 2011

Who Really Moves The Price of Oil? Saudi Arabia, IEA or The "Hidden-Hand"? (Guest Post)

By Andrew Butter

First impressions it looks suspiciously like the bold experiment to strut the power of USA as a player in the oil-price conundrum; looks set to be about as successful as the $4.7 trillion campaign to achieve, I still didn’t figure out quite what, in Iraq and Afghanistan….err…and perhaps Libya?

The day-before IEA announced the release of two-million barrels of oil a day for a month, Brent closed at $113. A week later it closed at $112, i.e. it dropped 1% overall in a week.

That’s hardly Mission Accomplished however you spin it, particularly compared, for example, to a week after the Saudi’s said they would go the other way to OPEC ($111 compared to $119 a week earlier i.e. 7% down), and a week after God’s Workers pronounced the banana was getting over-ripe when it was $ 124 compared to $127 (4% down).

Of course, none of that comes close to the drop in the week after the Chimp pronounced on 30th April that the oil-bubble had peaked (12% down: $126 to $109), which is perhaps not surprising, given that Nassim Taleb, the author of the Black Swan, says Chimps are much better at picking numbers for the future than the Students of Econ-101.

And that proves? Well either the oil-market is more influenced by the musings of a Chimpanzee than by the combined efforts of the IEA, OPEC, Saudi Arabia and God’s Workers, put together…or the Chimp is psychic, or there is a Mysterious Hidden Hand Manipulating the price of oil, that only Chimpanzees can see?


The dashed lines are simple regressions from the day the pimple appears to have reached its zenith, that was the day that God’s Workers told their flock the news. The red line is the “best-fit” down to the day before the IEA made their pronouncement, and the green line is the best-fit to last Thursday.

So if you squint you can say that the bold action of the IEA hastened the fall in the price of oil (54% R-Squared compared to 40%), although the t-statistic is miniscule so that’s “not statistically significant”.

All I can say is that I’m sorry I suggested the idea of using the SPR as a weapon of fiscal management in early April; when I argued (somewhat sarcastically), that the Federal Reserve should be put in charge. My point was simply that the 35% rise in oil prices since January 2011 was completely due to speculation, and that speculation had been funded by the Fed’s monetary policies.

So it made sense for the Fed to manage the SPR, because their mandate, as is frequently summarized by Ben Bernanke when he desperately repeats and re-repeats his job description, like a lost soul wandering in the dark repeating a mantra, is as in:

The Federal Reserve's objectives -- its dual mandate; set by Congress -- are to promote a high level of employment and low, stable inflation stable economic conditions, keeping inflation in check, and creating jobs.

The problem of course is that the mandate did not SPECIFICALLY say the jobs should be created in USA, which is why most of the jobs the Fed helps create are in China.

Either way, speculation in oil is bad for USA because it means they pay more for oil that they cannot avoid importing, and the way their trade deficit is running, that means they have to borrow from “aliens” to pay for it. And it’s bad for the world economy too, which means the few world-class industries left in USA sell less to the “aliens”.

More important, it prevents the development of new sources of supply or alternatives because sensible finance won’t invest long-term when the short-term market for the thing they are investing in, behaves like a yo-yo.

When a geek in Exxon put’s up a forward-cash flow on his Power Point for a $500 billion project to develop deepwater oil; there are three numbers he needs to put in the Excel sheet for Year-10 to calculate his NPV. One for “base-case” one for “stretch- case” and one for “low-case”; sensible financiers (not the ones who created the credit-crunch), always look at the “low-case”, and the thing about bubbles, is that the next thing that happens, is you get a bust.

You can argue that’s the Black Swan Scenario until you are blue in the face, but when the discussion turns to how much LTV and DSCR they will let you get away with in your model, they draw a line linking up the dots of the bottoms of the troughs of the busts.

And if any of the Students-of-Econ-101 tell me that markets should be “allowed to find their own equilibrium” and that the roller coaster ride of oil from $75 to $147 and then down to $35 and back up to $90 in 2010 was a perfect example of efficient markets finding that equilibrium, I’m going to slap them.

The oil market fundamental is dictated by Parasite Economics. In that analogy, the customers (particularly USA) are the “hosts” (as in Daisy the Cow), and the parasites are the ones drinking the milk (as in Saudi and Iran). The trick, for the parasites, is to make sure Daisy doesn’t get a nasty dose of mastitis and keel over and die; the cost/benefit optimal of that is the “fundamental”; assuming of course oil is not running out in which case the “fundamental” is the cost of replacing all of the oil that was once there but now isn’t. Try looking all that up in an Econ-101 textbook.

It makes no sense to rely on the “invisible hand of the market-place” to deliver a “fair-price” when the market-place is distorted by the invisible hand of God’s Workers manipulating the market, just like they manipulated the silly indexes that were used to price toxic assets in the good-old-days, which caused the credit crunch; remember that?

My argument was that if you are in the business of manipulating the monetary base, you need to think about manipulating the price of oil too, so as to protect yourself against the unintended consequences of handing out free-money to speculators, so they can screw you.

Whether central banks should be allowed to be in that business so as to cover-up the incompetence of the legions of “democratically elected” sleazebags which is what passes for “government” these days; is something that’s been debated since the fall of Rome. But that’s another story, all I have to say about that is in a Real Democracy there would be a box on the ticket saying, “None of the above”.

But when I wrote that article, I wasn’t suggesting that President Obama should bring in the IEA to shoot him in the foot.

Yet that’s what happened, the IEA fiasco is too-little, too-late, and much too stupid. “Manage” means getting someone who knows what they are doing, to “sell-high” and “buy-low”, an ex-Goldman Sachs sleaze-bag would have been ideal to do that sort of “God’s Work”; with a mandate to (a) make a profit (naturally), and (b) to keep the commodity traders who generally serve a vital economic function but occasionally need to be slapped-down…honest. And the trick there, like in any guerrilla-war, is they will never know when you are going to sell, or when you are going to buy, until after you did.

Have no illusions, it’s a guerrilla war, because the weapons the “good-guys” got are miniscule compared to what the “opposition” has. The SPR is 270 million barrels of oil, that’s 20-days production by Saudi Arabia going flat out; at least once they get those pesky 32” pigs out of the pipe. America may have the biggest (and most expensive) army in the world, but when it comes to oil they are just a big fat cow on a feed-lot, waiting for lunch.

My best mate these days is a lunatic called Eddie who has three bullet wounds and one of his fingers is a lot shorter than the one on the other hand, on account of the IRA cut it off with a pair of garden secateurs; which is not something he would recommend you try at home. For his sins, which these days mainly relate to Jack Daniels and the girls, once he was a sergeant in the SAS; so he knows a thing or two about how to “influence” events.

One day he explained to me that it’s not so much what the SAS do when they get parachuted in somewhere, it’s the fact that the enemy know they are there, but they don’t know where they are. The message I got from that is sometimes it pays to not telegraph your punches.

Particularly if you are the Federal Reserve or a proxy for it, as in did you notice the 100ytear went down to 3% just like the Chimp said it would last December, wonder why? The recent addition to the bull in the sweet-shop is the IEA, as in the players will never “Fight the Fed (or the IEA)” but they will happily lead it around by its nose.

The correct time to have started planting mines to blow random feet off unsuspecting speculators was in February 2011 when oil peaked its nose above $100.

If that medicine had been dished out then (quietly), the word would have got around, “Don’t Fight the Fed”. And oil might well have returned to its proper, sustainable price of $90, as in the one where the parasites get free milk every day and Daisy doesn’t keel over and die.

Why $90?

Well for a start that’s what SPOOF (The Standard Pricing of Oil Formula), says it should be right now, as in, to express that in the hieroglyphics so loved by the Students-of-Econ-101:

FOOT = 3.3% TOAD/OIK.

OK, you might not buy that logic, particularly if you are a Student of Econ-101, as in “we are proud that we figured out 101 ways to shoot ourselves in the foot”, but just remember that was the same logic what said the S&P 500 would bottom at 675 (it did), and then meander up to 1,200 (it did) and then reverse by 15% (it did), and then the 10-Year Treasury would hit 3% about now (it did).

But don’t listen to the Chimpanzee, get a second-opinion. Well the Saudi’s say the “right price” now is $70 to $100; depending on their mood and they never specify if they are talking Brent or WTI, and the head of Exxon which recently discovered 700 million barrels of deepwater oil off New Orleans, told Congress that he would be happy to keep on doing that (and not spill it all over the ocean), if oil prices stayed above $75 (presumably WTI).

No definitely don’t listen to the Chimp, listen to the experts, although, here’s a thought, perhaps they been reading his mail?

What did the IEA do wrong?

1: They “telegraphed”, just like Ben telegraphed QE-2, and so he ended up paying top-dollar for laundering Tim’s short-term debt into some slightly more palatable longer-term stuff.

Then to cap it, they put a time limit which is always a mistake; just like putting a time-limit on military disengagement. First you tell the enemy you are going to attack (so he starts manufacturing road-side bombs), then you announce when you will run away with your tail between your legs shouting “Mission Accomplished” in a loud voice, so he starts manufacturing more road-side bombs.

2: They don’t have a distribution network, even a Student of Econ-101 knows that to sell anything you need distribution. Instead you got a bunch of bureaucrats setting up auctions!! The IEA or their proxies are turning up at the back-door of refiners and saying “Hey-sweetheart, you want to buy some oil…and kick your normal supplier in the teeth, the one who you have been dealing with for twenty years, and the ones who gave you an allocation?”

“That’s a great idea, patriotic too, but…Err…what about next month?” Remember the price of Brent is the price of Brent in the market, what some moron PhD from the IEA manage to sell his bucket oil for, is something else completely, as in the “right” price of oil is what you can buy it for from someone dumber than you.

They formed an “alliance” and didn’t put anyone clearly in charge apart from a bureaucrat, sounds like the EU response to Greece and the military action in Libya.

And like Libya, WMD, and Rumsfeld’s bunkers, don’t have a sensible objective. The stated objective is to “replace” oil lost to the Libyan Rambo Charlie Foxtrot. So the objective is “military”? As in why not just let the Saudi’s go in and cut a deal with Gaddafi so he goes away?

Not many people know this, but just prior to 9/11 the Saudi’s were close to agreeing a price with the Taliban to hand over Bin Laden; $28 million was the sticking point, another $5 Million and there would have been a deal.

But no, Rambo decides to go out and borrow $3.7 trillion to do it his way. Don’t under-estimate how much money it will cost, and how many innocent lives will be lost, before David Cameron’s rush for the title of “World-Statesman” like his hero Tony Blair, gets tidied away.

There are only TWO sensible reasons for selling oil from the SPR, (a) to sell high and buy low (i.e. sell at $127 when the Chimp said-so and top up at $110), (b) to pop a bubble. But the bubble is popping and in any case the Saudis got it covered, once they sort out those two little piggy’s stuck-in-a pipe.

Apart from being stupid, it was just plain rude.

Didn’t anyone NOTICE what the Saudi’s did on 8th June? Their point was a bubble in oil is bad for the world economy and a simple “thank you” for deciding to pump to bust the bubble would have been enough.

All through the 2008 bubble the Saudi’s were saying “it’s a bubble”, and its clear now, that in hindsight it was a bubble. The way you can tell is that (a) there was a bust after what looked like a bubble and (b) the square-root of the top of the bubble multiplied by the bottom of the bubble, is exactly equal to what the Saudis had been saying the right price was, all along.

This time they are saying it’s a bubble too; perhaps sometimes it might be a good idea to listen to what they are saying. But what’s weird about the Saudis is that they said, and they keep on saying, that bubbles are bad for business, and bad for the world as a whole; instead of just grabbing the money while they can.

On 8th June, they stood up to the countries in OPEC who would like the world to “suffer for its sins”, particularly America (i.e. Venezuela and Iran), and they said “stop behaving like children”.

And they committed (along with UAE and Kuwait), to pump oil that they don’t need to sell, since they have more money than they know what to do with and long-term they know that they could get more money, much more money, for that oil, if they just left it in the ground.

Are they mad?

Well perhaps they are, or perhaps they think that they must kiss the posterior of the World’s Greatest Superpower which recently spent $4.7 trillion dollars of borrowed money achieving precisely nothing in Afghanistan and Iraq. Perhaps, and perhaps the King of Saudi Arabia goes to bed every night saying a little prayer, “God Bless America, may she long keep me in power and deliver me from the Iranians”.

Or perhaps the reason that the Saudi’s and other like-minded GCC states are about the only nations in the world behaving like responsible adults these days, is because of they think it’s the right thing to do.

And perhaps that “weird” philosophy has something to do with the idea that under Islam it is considered to be dirty, to “profit from other people’s misfortune”? Bubbles are zero-sum, they rely on getting people to pay more than the intrinsic value of “things”; and they are driven by the profit that the sellers can make, selling “things”, in the words of the philosophy of God’s Worker cynics, “to someone dumber than you”.

Here’s an idea, regardless of where their philosophy came from, perhaps Saudi Arabia should get a Permanent seat on the UN Security Council?

After all
  • (a) they do represent the second biggest religion in the world, and probably the biggest if you only count people who actually practice
  • (b) when the whole world is behaving like lunatic children, they consistently behave like adults
  • (c) they control the one thing that can derail the world economy, and no, that’s not nuclear bombs or the ability to drop cluster-bombs from 10,000 feet, it’s called “OIL”.
And while we are on that subject, the way to do that would be to chuck out France and UK and give one seat to the European Union, and one to Saudi Arabia. After all, France and UK are not exactly World Powers anymore, as in how many Tornadoes did the Brits send to bomb Libya; was it nineteen or was it sixteen?

And in any case the Tornado is an aged interceptor which these-days is only good for blowing up airfields; that job took five minutes…and for an encore? Well that’s easy, call in GI Jane, she has lots of money to pay for ordinance, after all she borrowed $4.7 trillion to blow up all those WMB, there has to be more where that came from.

Perhaps next time a smooth talking “World-Statesman” with a public-school accent and a seat on the UN Security Council, eggs on Rambo to start dropping precision guided cluster bombs from 10,000 feet in the name of the New World Order, the message comes back, “Sure-thing buddy, just send us a cheque”. But don’t hold your breath.

The Mysterious Hidden-Hand

Well it’s not Saudi Arabia, obviously, nor is it the IEA fronting up for the Americans; and well God’s Workers, they are just good for blowing bubbles and persuading dumber-than-thou German and French bankers to buy Greek debt.

Blowing bubbles is one thing, popping them is something else, that’s where the mysterious Hidden-Hand comes into play.

The reality, right now, is that although medium-term there is the distinct possibility that oil will run out, short-term there is no shortage. And don’t for a moment think that Iran, Venezuela and Nigeria are going to cut back 1.5 million barrels of oil a day, just to keep the prices high so Saudi Arabia makes can make a killing selling the additional 1.5 million they are promising to pump.

No-way, their idea was that Saudi should “sell-low and buy high”, and there are much too many individuals in those countries taking a cut and squirreling the money away in Switzerland and Dubai, for them to “make the sacrifice”.


But regardless of how many of those new-fangled road-side bombs that can cut a HUMVEE in half (literally), like what happened to those three pour souls from Olive the other day; are smuggled over the border to destabilize Basra, and slow down the pipeline work; Leighton Offshore are miles ahead of schedule.

Particularly now they decided to change the pipeline route so it avoided the stash of UK-Made phosphorous bombs that were dumped in the sea; plus they figured out a way the deal with the silt. Someday soon there will be another 1.5 million barrels a day (or more) pumping through those three SBM’s. And well, Exxon says they can pull out deepwater oil and make a profit at $75, and have change over to pay to clean up the Yellowstone River.

And all the while, slowly, imperceptibly, in the background, the "Hidden-Hand of Bubble" works its magic.

(Read about why EconMatters sees $80 Oil by September.)

About the Author - Andrew Butter is Managing Partner of ABMC, an investment advisory firm, based in Dubai that he set up in 1999, and has been involved advising on large scale real estate investments, primarily in Dubai.

The views and opinions expressed herein are the author's own and do not necessarily reflect those of EconMatters.

EconMatters, July 5, 2011 | Facebook Page | Twitter | Post Alert | Kindle

Advertisement