So oil prices are rising, and, inevitably, a debate is heating up about the role of speculation versus that of â??fundamentalsâ?. Ryan Avent makes a point that was commonplace last time our collective heads were on fire about oil prices and it was all the speculatorsâ?? fault:
I thought this was a good point in 2008, the best rejoinder to Paul Krugmanâ??s recurring query that, if itâ??s speculation, where was the inventory build? But it strikes me as a less compelling point now.
Suppose you are the House of Saud. Like anyone with a position in a traded asset, you face a sell or hold decision. If you expect that the real value of your asset will rise faster than the real value of financial investments you could make at equivalent risk if you sold, then you should hold. Otherwise, you should sell.
But thereâ??s a wrinkle. The House of Saud really must compare the private value of oil in the ground to the private value of alternative investments. Like a middle American muni investor maximizing after tax returns, the House is looking to maximize the value it can actually appropriate. Ordinary taxes arenâ??t that big a deal to the Saudâ??s, who after all run the state. But the House of Saud faces a different sort of â??taxâ? on future oil: the possibility that by the time it is exhumed from the desert, it will no longer be theirs to sell. The expected private value of future oil to the House is proportional to the expected future oil price and inversely proportional to the probability of revolution. Iâ??d guess that events of the last few months have significantly reduced their expected private value of oil in the ground, the current oil price spike notwithstanding.
One might even argue that current circumstances amount to a natural experiment by which we might test the question of whether Saudi Arabia in fact has 3.5M barrels a day of spare capacity they can easily bring on line, or whether theyâ??ve basically been running full tilt already. As the probability of revolution â?? or else a permanent increase in wealth-sharing to forestall revolution â?? increases, the private value of oil in the ground falls. If flows donâ??t increase, that could be taken as evidence that the Saudi Arabia is pumping at capacity.
Of course, life is messy, and natural experiments are never perfect. Lots of caveats: The pump-or-store decision should be based on the relative private values of oil and financial investment. If the princes think that, after a revolution, their financial wealth would be frozen by fair-weather patrons in the West, that would tilt things in the opposite direction. The princes might believe that defending their claim to oil in the ground is a better bet than relying upon recently less than reliable Swiss bankers to protect the interests of unpopular clients. (A strange corollary of all this is that if the West wants to maximize current oil flow, it should credibly promise to recognize the House of Saudâ??s claims on private and sovereign wealth, come what may on the Peninsula. I do not advocate this â?? I think we should put longer-term interests before concerns about the momentâ??s oil price. But the logic is clear.)
Also, the princes would have to be mindful of potential backwards causality from pumping decisions to revolution. If it looks like the rulers are ramping production in a panic, that might signal fear and undermine the governmentâ??s legitimacy, aiding the revolutionariesâ?? cause. However, the current price spike and concerns of oil consumers would provide cover. There are lots of reasons besides fear of regime change why the Saudi government might choose to increase production now, if they can.
Obviously, all of this is, um, speculation. Interfluidity is not the The Oil Drum. I know little about the details of oil production or of Saudi politics. But from the perspective of several Middle Eastern regimes, Iâ??d guess that â??oil in the groundâ? seems less of a safe bet than it might have a few years ago.
There are two sides of this coin as well.
The scent of revolution will reduce the potential costs of pumping oil (by reducing the Saudiâ??s discount rate) but it will also increase the potential benefits of selling oil for more cash, as more money maybe what is require to buy off the population and avoid the revolution in the first placeâ?¦
Good post. Iâ??ve worked in the biz and can say oil companies, much less national oil companies, do not speculate on the price of oil. They are too smart for that and realize they are not capable of predicting the future price. If oil producers were good at speculating over the future price of oil, they wouldnâ??t be producing oil, theyâ??d be hedge funds.
One might even argue that current circumstances amount to a natural experiment by which we might test the question of whether Saudi Arabia in fact has 3.5M barrels a day of spare capacity they can easily bring on line, or whether they've basically been running full tilt already. As the probability of revolution "â? or else a permanent increase in wealth-sharing to forestall revolution "â? increases, the private value of oil in the ground falls. If flows don't increase, that could be taken as evidence that the Saudi Arabia is pumping at capacity.
Interesting take. Personally, I donâ??t think that the chance of revolution in Saudi is all that highâ?¦ but food for thought nonetheless.
Perhaps a new twist in the â??call on OPECâ? tale?
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