My much awaited “brilliant” post on the oil price plunge. Actually a brain flash I wish I’d had 6 months ago.
- Oil is in a recursive downward spiral until a (very) rational (Saudi) actor decides to stop the cycle.
- The “stop” signal(s) will be a wave of bankruptcies among US shale producers and deep economic pain in Iran.
- We have seen neither so far.
- So oil will continue to suck for a while yet.
The main insight was that we have a human actor in the driver’s seat. This is not a garden-variety supply/demand imbalance price cycle. It was deliberately ignited and fed by the Saudis. So you just have to figure out what the Saudi definition of “success” is. That is when this cycle ends.
“Success” is probably. 1). A lot of marginal producers out of the market (US shale & nascent shale efforts in other countries). 2). A lot of pain in regional rival Iran.
I don’t have much to add on Iran. But it looks like the Saudis under-estimated shale’s potential for efficiency gains. This is a very human cognitive failing.
- People only find real efficiencies under duress. Inertia is otherwise too powerful and imagination too weak.
- People also tend to assume things are already efficient (inertia and imagination failures again) so they overestimate the impact of stressing a system.
But the Saudi’s are now committed to their strategy – no matter how miscalculated. So expect oil to keep sucking wind until things get much worse in the energy sector (and Iran).
This should be good for the global economy once everyone figures this all out. Huge drop in input costs = more consumption of useful things vs palaces in London. That should be good for the stock market (ex-energy). Which suggests the current moment is just a kerfluffle. So we should all be buying. Which I am doing. Although it doesn’t feel very good… Which should be a good sign I’m on the right track. Although it doesn’t feel very good… 🙂
PS: The other interesting thought exercise is: “what happens if we run out of places to put the surplus oil?” Everyone is still pumping. Not trying to outrun the onrushing bear. Just the guy running away next to them. Reports are that crude storage tanks are already at capacity, with excess going to rented, slow-steaming supertankers being used for floating storage. Do we see a spike in supertanker rental rates as that capacity also gets tight? And where else would you put it? Per the above, the system will likely find more room once stressed. But maybe the clever trade is to buy increasingly unlikely venues for oil storage? Or just oil tanker capacity? That is a trade I won’t be exploring, but someone probably makes a lot of money on it.
