By Chris Cook, former compliance and market supervision director of the International Petroleum Exchange. Cross posted from Asia Times
The end game is about to begin. On the one hand you have the noise and rhetoric. Greedy speculators gouging gasoline prices; mad mullahs preparing to wipe Israel off the map; bunker buster bombs and fleets being positioned; huge demand for oil from the BRIC countries; China’s insatiable thirst for oil; the oil price will head for $200 a barrel and will never again fall below $130 …
On the other hand you have the reality.
Oil Markets
The oil markets are completely manipulated and orchestrated, and the conductors of the orchestra have the benefit of having already held a rehearsal in 2008.
History never repeats itself, but it does rhyme. This time around it is not demand from the United States that is collapsing, but European Union and United Kingdom demand, as oil prices in euros and pounds sterling have never been higher. In the meantime, the US is awash in oil as domestic production quietly increases, flushed out by the high prices.
As I have outlined in previous articles, the culprit for the high oil prices between 2009 and 2012 – with the exception of the speculative “spike” between March 2011 and June 2011 driven by Fukushima and Libyan price shocks – has been passive investment by risk-averse investors, which enabled producers to support oil prices at high levels.
Much of this passive money underpinning the market and enabling producers to monetize inventory pulled out of the market in September 2011, and another wave pulled out in December 2011.
What is now happening is the end game: an orchestrated wave of noise that is drawing in speculative money. This is enabling the producers who are actually in the know to hedge by selling production forward during what they confidently expect will be a temporary – and pre-planned – managed fall in the oil price.
The Game Plan
The smartest kids on the block knows that gasoline prices much over US$4 per gallon will be both deflationary and lethal to President Barack Obama’s re-election chances. So that won’t happen other than briefly.
I am by no means the only commentator who has pointed out the complete counter-productivity of these oil sanctions. The smart kids are well aware that oil sanctions are completely useless, and simply enable China to fill its strategic reserves at a discount to the market price at the expense of Greece and Italy in particular.
But the US has been quite happy to let the EU – as useful idiots – take the economic hit. The high oil prices caused by all this noise and nonsense are actually a net benefit to Iran – which rattles its sabre loudly as elections approach.
The effect of a managed decline in oil prices to, and probably over-correcting well through, $60 a barrel – which is coming fairly soon – will be extremely beneficial to the US in two ways.
Firstly, it will be catastrophic in particular for Iran, Russia and Venezuela – not exactly on the White House party list – whose hugely oil-dependent revenues will collapse. The ensuing economic mayhem will open these countries up to regime change and to rescue plans which Wall Street will be dusting off.
Secondly, the US population will be laughing all the way to the gas station as gasoline prices fall – at least temporarily – below $2.50 a gallon and release purchasing power into the economy, thereby doing the president’s re-election chances no harm at all.
What will then happen is that members of the Organization for Petroleum Exporting Countries will panic and genuinely reduce their production. The Saudis/Gulf Cooperation Council will again orchestrate the inflation of the oil price – as they did in 2009 – comfortable in the knowledge that they have been able to hedge against this temporary fall in prices at the expense of the speculators currently pouring in to the market.
That’s the game plan as I see it of the smartest kids on the block. What could ever go wrong?
A Buyers’ Strike
Quite clearly, consumer nations, like everyone else, are in the dark in relation to what has been going on in the oil market and have swallowed the populist “greedy speculator” meme. They are simply unaware of the nature and cosmic scale of the oil market manipulation that has been taking place, and as a result have been happily overpaying for oil for years.
What happens if they simply refuse to pay these prices?
Possibly a “buyers’ strike” by China would be enough to crater the market. We’ve already seen the effect of that on Iran, which has clearly agreed new terms with China after the latter held back purchases earlier this year.
Or possibly speculative short selling of crude oil by hedge funds funded by Chinese investment? I pointed out at a rather spooky conference on “economic terrorism” a few years ago in Lausanne – which examined ways in which terrorists might make economic rather than physical attacks – that the only difference between an economic terrorist and a hedge fund is motive.
System Fragility
The markets in oil have never been so fragile and susceptible to shocks. Private inventories of oil are low. The investment banks interpret this – as they interpret everything – as a sign of physical demand and therefore as bullish for the oil price … oh, and by the way, here are some oil funds they have to sell you.
The reason inventories are low is that private intermediary buyers will only store oil if they can both finance it and lock in a higher forward sale price. Bank financing is scarce and getting scarcer, while forward prices are below current prices; the result is that inventories are low.
The systemic shortage of finance capital means that neither physical oil traders nor the remaining proprietary traders of banks can afford to take into storage much of the approaching flood of oil onto the market.
Also, derivative market risk has become concentrated – since intermediaries are no longer capitalized to take it – in centralized clearing houses, which have for commercial reasons become fragmented silos.
In my view, the steep decline which is planned could easily get out of hand in a not dissimilar way to the tin market in 1985 when the price collapsed – literally overnight – from $8,000 per tonne to $4,000 per tonne.
We will then see whether the clearing houses are “too big to fail” – and ask why, if so, such utilities are run for private profit?
When, Not If
In my analysis, absent a massive, and sustained, shortfall in oil supplies – which I cannot see occurring, since all involved have every interest in ensuring it does not occur – the oil price will, as I have already forecast, fall dramatically by the end of this year’s second quarter at the latest. It’s not a matter of if, but when it will happen.
Finally, as an interesting aside, I have credible reports that Marc Rich – who got on well with both the Shah of Iran and Imam Khomeini, and who sold oil from Iran to Israel for 20 years between 1973 and 1993 – has recently been seen again in Tehran. I doubt that this is for the night life, or because he prefers Tehran air to Swiss: but as a trusted third party there would be few better placed to act as a go-between.
Let’s hope so. Once the stultifying political uncertainties of elections in Iran and Russia are over, things could get interesting.
So this will be like the 1980s when oil prices crashed leaving states and nations dependent on high prices high and dry and gas went below a dollar a gallon?
hmmnn…don’t think so-bushbama is no bushitter, so won’t get benefit of Wall $treet speculators selling off futures, just prior to elections…as was done 2004, noted by Gretchen Morgenson.
Also, oil companies during Iraq wouldn’t buy nationalized Iraqi oil till U.S. carried out “pacification”=protection of oil fields, from “terrorists”..Oil companies stated they had made more $$$ with OPEC than ever. They aren’t going to upset that apple cart. (Greg Pallast documented)
Let’s all remember, Wall $treet 2004, Goldman-Sachs owned world leading 13.8% of total oil futures…other Wall $treet banks owned also, were selling futures back and forth to one another, specifically to raise price$$…that’s the speculation game…goes back to 1800′s…
I’m not sure I understand the mechanism by which the price (WTI) drops from ~ $108.50 to $60.
thanks
Same as tin market in 1985?
I’m not really trying to be obtuse (it just comes naturally).
In the case of tin, was there some kind of acute demand destruction that drove the price decline? For oil pricing, what [specifically, here and now] would cause a steep decline in growth, especially given India and China’s domestic growth rates (and their apparent interest in absorbing excess crude oil production/exports)? Because it seems that the price drop would certainly not be due to a rapid increase in oil production or exports.
Anyway, thanks. I’ll go back to just reading
@Calcixeroll
The International Tin Council – a producer cartel – were able to keep the tin price high through stockpiling, and through forward purchases on the London Metal Exchange, which at that point was an organised bilateral market (like the London Bullion Market Association still is) and had no central counter-party clearing, and no regulation.
Over a period of years (tin mines take a good few years to get going) a lot of new tin production came onto the market.
Eventually the cartel were unable to continue the price support, and the price collapsed from $8,000/tonne to the lower ‘buyer’s market’ clearing level of $4,000/tonne.
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