Oil prices have been struggling to stabilize in the wake of the coronavirus (Wuhan virus) outbreak and the global panic developing because of it. True to form, some commentators have begun to describe this as a black swan event.
As such, I am drawn back to an Oil and Energy Investor article written more than five years ago. Then, the event was an OPEC decision to defend market share rather than price. That move ushered in an over 45 percent collapse in crude oil prices before the cartel (and outside “allies” led by Russia) began cutting production.
As I noted at the time, I have never been particularly attracted to this way of “describing” matters observers had not expected or could not predict. Basically, a black swan is an outlier, a development that fails to follow any normal pattern.
Black swan theory has been popularized in the work of Nassim Nicholas Taleb, a well-known risk analyst and statistician. Taleb wanted to develop an approach that could deal with: (1) the disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology; (2) the non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities); and (3) the psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs.
To put matters in perspective, Taleb considered World War I, the breakup of the Soviet Union, 9/11, and the Internet as examples of black swan events, so these are hardly everyday occurrences.
Almost 20 years ago, Taleb applied his approach to the stock market and ended up as a regular on financial TV thereafter, whenever matters seem to be going well off course. As a consequence, this has led to the black swan being used as an “explanation” for all kinds of things. It is the obverse of the “this time is different” mantra.
Well, over the past week there have been several attempts to claim the Chinese virus as a black swan event.
Some Black Swans Look More Like Clay Pigeons
First off, there have been indications on both the supply and demand sides that matters were softening. Second, far too much is being accorded to the economic impact of a prolonged virus crisis. As the last Oil & Energy Investor observed, the data supporting a pronounced pressure on energy demand are not there. Even if this happens, it will require at least six months of tangible figures before any such judgment can be made. But the orchestration of talking heads commentary on the tube has made the matter a fait accompli.
It is also not the stuff of a black swan. Unless, of course, there is another motive and the black swan becomes a convenient cover. This appears to be what is underway in a cyclical pattern that seems to emerge every few years whenever an outside pressure affects the perception of where oil price ought to be…
We are in a new age of massive short plays and swaps. The coordination is staggering with an impact that is immediate. Especially if there is segue to policy makers. On no tangible basis whatsoever, some pundit claims that oil will move down as a consequence … and presto! Within a few days that’s where we are.
However, the reliance on shorts to profit in times of uncertainty has become less a reflection of market dynamics and more the penchant to make profits by artificial means. This has become more a strategy when outliers crop up if those making decisions on the supply side are themselves involved in the short manipulations.
The Devious Business of Investing Oil Revenues
One of the things I have been tracking for a while is how officials in oil producing countries have been positioning sovereign wealth funds (SWFs).
These funds have been designed to invest the proceeds from national revenues. Usually, the better a country’s balance of payments, the stronger the SWF. This is always a result of a trade surplus – more is exported out of a country (being paid for by somebody else) than is being imported (requiring payment).
Until the tariff war with the U.S., China had been leading in this category. Even today, in the wake of Trump trading policies, Beijing still has a surplus with the rest of the world.
But most of the SWFs of consequence these days involve investing the proceeds of oil sales. In the case of oil producers, that has usually meant the success of an SWF was perceived as dependent on the price of crude. The higher the price, the greater the leverage when it came to investments from an SWF.
Now these funds are almost always conservative, looking for a guaranteed or long-term over a higher, but riskier, return. That explains SWF investments in Rockefeller Plaza or hotels on the one hand, or dull but secure 1.5 percent annualized return from some other nation’s sovereign low-interest bond on the other.
There is also the problem of limiting the financial downside from introducing the proceeds directly into a domestic economy. Given oil revenues are overwhelmingly in U.S. dollars, direct introduction ends up inflating the local currency rather quickly.
So, the sales proceeds are largely segregated from domestic trade, kept outside the country, with the profits from investing introduced in ways to minimize the inflationary impact.
All of which has triggered a new development. SWFs have become a player in the market shorting the very product responsible for the funds to begin with. Some OPEC members are making money on both sides of the crude pricing curve.
Transacting the deals outside their own borders via SWFs, these countries are hedging product in both directions. Currently that means they are pushing forward the crude market price lower by pairing shorts to actual oil consignments.
This is manipulating a market, equivalent to a poker dealer having the ability to read everybody’s hand before placing a bet.
But there is one thing it certainly isn’t.
This is no black swan. Looks more like a vulture to me.
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