Secrecy has characterized the oil business ever since a slick Armenian named Calouste Gulbenkian finagled a concession out of the Ottomans and middle-manned partnerships amongst the “Seven Sisters” to exploit Mesopotamian oil, gaining him the sobriquet “Mr. Five Percent” from the commission he customarily took for his efforts. That the industry is still cloaked in secrecy is manifest in the lament of the Financial Times in an article entitled “The Decline of the Oil Spot Market” that, “Unfortunately, thus far, no-one we’ve contacted has been able to give us any estimate about the real size of the spot pool as stands now.”
The spot market is the basis for the price of oil you see quoted in the press. It’s where crude oil is bought and sold, yielding the West Texas Intermediate (WTI) price as set on the New York Mercantile Exchange.* The volatility of oil prices over the last couple of years has got me wondering whether the price can be “gamed”, meaning the price being set through manipulation independent of changes in supply or demand. What set my mind a-wondering is the dramatic drop in price from 2014 to 2016 and the record-setting decline currently.
The steep plunge starting in 2014—from over $100 a barrel to less than $30 by 2016—coincided with tense relations between the United States and Russia consequent to the Russians annexation of Crimea. Such a collapse in the price of their major export must have been a real whammy for the Russians (and secondarily for the Venezuelans, with whom we also have problems). Could it be we engineered the collapse? Now we see a similar collapse just as we try to squeeze Iran by stopping the export of its lifeblood. Unable to accomplish a total embargo on Iranian oil, are we contriving to see that Iran is forced to sell its oil at fire-sale prices?
Is gaming such a huge and complex market as the global oil trade possible? Not if you listen to the experts. They all sing the Energy Information Administration’s tune that price is “determined by supply and demand”. If the price goes down, it’s because Saudi Arabia has increased production, US production is on the rise, there’s a glut on the market, demand is weakening, yada-yada-yada. Contrary facts fail to disturb the harmonious trilling of this jabbering flock.
For instance, in 2014, when Saudi Arabia was said to be flooding the market to maintain their market share in the face of booming US production, Saudi production did not actually rise in sync with the drop in price. Nor did OPEC’s. US production did rise from around 8.5 million barrels per day (bpd) in mid-2104 when prices began to fall to a little over 9 million bpd by mid-2016 when prices bottomed out, but imports of crude oil remained largely unchanged. Non-OPEC production rose by 2 million bpd, but in a 90 million bpd market was this sufficient to cause a 70% decline in the price of oil?
Similarly, the decline we’ve seen in the last month and a half cannot be attributed simply to changes in supply or demand, despite the entrails interpreters of the business press looking to supply/demand fluctuations to explain the current plunge, as is their wont (see “The 7 reasons behind U.S. oil’s sharpest daily point drop in almost three years”). One such claim is that the waivers to the sanctions on Iran granted by the Trump administration increased supply by boosting Iranian exports; but in November, during the biggest one-month decline in the price of oil since 2014—including a record-shattering 7% drop in one day—Iranian exports actually decreased by several hundred thousand bpd and were over a million bpd below the level last spring.
Let’s leave the gurus to their fatuous jargon about “oil fundamentals”, “risk/reward outlooks”, “cross-asset sell-off”, and the like and pursue the question I raised initially: can the price of oil be gamed. First, some market fundamentals. Crude oil is purchased on the spot market or under long-term contracts. Platts, a leading voice in the energy business, ventured a guess that 90-95% of oil production is sold under long-term contracts. That leaves just 5-10% for the spot market, or roughly 2 to 4 million barrels per day.
Purchases made under long-term contracts do not concern us here, as the “price of oil” cited in common parlance is based on trading on the spot market. Purchases on the spot market can be for immediate delivery or for delivery months into the future. Purchases for immediate delivery do not concern us either, as the “official” price is based on the amount paid for delivery two months out. The relative volumes purchased for immediate versus future delivery are not known; but, for the sake of argument, let’s stack the odds against gaming by assuming the spot market handles 10% of the crude oil trade and that all purchases are for two months out, for a total of 4 million bpd.
Is it possible to game a market of that size with its multitude of players? Platts thinks so. That’s why they call it an “overarching concern” of the industry that “no single entity or logistical constraint should be able to control the benchmark [price]”, so let’s consider how it might be done. The largest trader in the oil business is a Swiss company called Vitol, which boasts of trading or shipping 3.6 million barrels of crude every day. How much of that is traded on the spot market and how much for future delivery they don’t say, but if it’s in the 1 to 2 million bpd range, it seems they might be influential enough to manipulate the price by repeatedly lowering their asking price, especially as they would only have to engage in trades in the two-months out timeframe to affect the daily price. No oil need even change hands as trades can be purely financial transactions between buyer and seller (called “swaps”), based on the market price the day of the (virtual) purchase versus the day of (virtual) delivery.
Is Vitol likely to bow to pressure from the United States?*** Even bigger entities than Vitol, namely European governments, find it advisable to acquiesce in American demands, e.g., US sanctions on Iran, so I suspect Vitol would, too, especially as its collaboration would no doubt be generously rewarded by its well-heeled puppet master. Moreover, Vitol’s nefarious history suggests they’ve got a liking for international intrigue, having been charged in the past with circumventing the UN oil-for-food program in Iraq, organizing a controversial sale of Libyan oil to Qatar, and trading with Iran in violation of EU sanctions.
Any gaming of the oil price can succeed only so long. In the end, the true supply/demand equation of the physical item involved—oil—will win out. What might be the game-ender in the current case? Perhaps Iran being able to switch from sales on the spot market to long-term contracts buffered from daily price swings. Or OPEC, prodded by Saudi Arabia, cutting production by a sizable amount. Or maybe the United States deciding low prices are hurting it’s vaunted—but expensive—fracking boom too much. Whenever the game ends—if a game is indeed on—you can bet oil prices will be going up.
As to my core question, my bet is that the price of oil can be and is being gamed; but, in true market speculator fashion, I’m going to hedge my bet. Admitting—with no false modesty—the superficiality of my knowledge of the oil business, I fear I may be mimicking the Gilda Radner character from Saturday Night Live who would take off on some animated harangue based on a gross misconception, e.g., her concern over “Soviet jewelry”; then, when informed of her mistake, meekly murmur “Never mind”. So, in anticipation of someone more knowledgeable pointing out my own ill-informed boner, I’ll conclude with a preemptive “Never mind”.
*This discussion will deal only with the WTI price on the assumption (a big one!) that the conclusions reached here apply equally to the international price, known as “Brent” from the name of an oil field in the North Sea.
**When the experts talk about demand we should always remember they are talking about the demand for oil by those who can afford to pay for it. In a world where two billion people cook with animal dung, true demand is never met.
***An intriguing sidelight is whether it’s legal for the US government to engage in such actions. I suspect it can, under the anything-goes-when-it-comes-to-national-security exemption.