Fundamentals or funds? While the International Energy Agency may have spent most of the spring Oil (NYSE:USO) boom pushing the meat-and-potatoes story of crude pricing as a product of the global supply-demand ratio and a flagging dollar, the volatility of April and May has had a number of analysts, including Goldman Sachs (NYSE:GS), evoking the dread specter of a speculative bubble.
When crude prices dipped back below $100/barrel last week, we even had our choice of financial and indicator culprits: unexpectedly high US oil reserve figures combined with a hiccup in Chinese (NYSE:FXI) auto sales, then we saw cooling global demand projections and the CME’s (NASDAQ:CME) hiking of trading margins for oil and silver (NYSE:SLV). All these variables likely forced a number of traders to partially liquidate for reasons having nothing to do with the tangible oil market.
Of course, these competing narratives for oil’s post-crash resurgence and recent volatility (NYSE:VXX) are not mutually exclusive. If it is hard to envision traders jumping back into the flames that scorched them in 2008 without the medium-term promise of flagging non-OPEC oil output and burgeoning Chinese auto sales, it is just as difficult to interpret their reaction to the Arab Spring as a sober and measured response. What the recent surge instead lays bare is that, far from untethering market outcomes from market indicators, the psychology of commodities trading promotes a hypersensitivity to those fundamentals.
To recap, the unrest of the spring has witnessed the complete shuttering of Libyan oil output. How big of an oil shock is this? So big that Saudi Arabia had to dip slightly into its substantial reserves to just about cancel out the loss in production, with North America chipping in to actually raise global supply by roughly 400,000 barrels per day since last quarter.
Yes, the replacement of Libya’s light sweet with sour alternatives dealt a legitimate hit to West International and Brent stocks, but can we truly tie a 35% hike in crude spot prices and a 33% spike in retail gas to processing cost increases impacting less than 2% of the world oil output? To contrast, the Suez Crisis and 2004 Venezuela/Iraq War shocks saw actual global output declines of 10% and 4% respectively, and in neither case resulted in such a price hike.
Obviously, the tale is not complete without mentioning the Saudi elephant in the room. To be sure, the fall of Riyadh, or even serious hints in that direction, would carry cataclysmic consequences for the world oil market, and violence between Saudi riot police and Shiite protestors last March may have had just as decisive an impact on rising prices as Libya’s descent into civil war. Yet, apart from Oppenheimer’s Fadel Gheit, one is hard pressed to find any analyst who seriously considers Saudi revolution a plausible near-term outcome, nor is it easy to envision a scenario in which the kingdom’s weak civil society could manage to not only oust the House of Saud but also prevent the major US military (NYSE:PPA) presence from protecting the Saudi tap.
Ultimately, the task of betting on not just market outcomes but others’ predictions of those outcomes forces an outsized appreciation for risk and opportunity. Attempts to isolate futures speculators as independent agents of price increases will inevitably fail as their overreactions lead directly back to “fundamentals”. We find ourselves confronted not by abstract, mysterious manipulations, but by good old fashioned, headline-driven volatility (NYSE:VXX), and it’s here to stay.