Friday March 27, 2026 Update

Keeping up with the daily chaos is difficult, but I suppose that's the M.O for the Epstein Class--keep everyone chasing ledes while they rape and plunder. That said, in today's first installment: 

1. The TACO Index is flashing red.
2. "The Trump Doctrine", one analysts attempt to determine where a US landing might occur.
3. Your daily fraud take.
4. Propaganda 

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As I mentioned the other day, Deutsche Bank created what it called The Pressure Index, but what is commonly referred to as The TACO Index. The index is comprised of the economic factors that dominate Trump's decision making: stock prices, oi prices, interest rates, and inflation. I don't have access to the current index, but we can certainly find the movements of its components.

 

 

    The S&P 500 fell 1.75% yesterday and is down another 1% as of 10 a.m.  Oil ended yesterday's close at $93 and is currently trading at $98. The 10-year T-bond yield is nearing 4.5%, which is the highest it's been since last July. 

    All signs point to a TACO moment today. However, investors aren't stupid. Trump's comment yesterday about extending the deadline for bombing Iran's oil infrastructure was another attempt to reverse the rising TACO trend, and while oil prices did reverse for a brief period, they turned back up toward the end of the day. If Trump wants to move markets today, it's going to take something a little more believable. Will he announce, while looking in the mirror, "We have an agreement"?  Stay tuned.

 

 The Trump Doctrine

    There has been so much chatter about the movement of elite US military units to the Middle East conflict zone, and most of the speculation surrounds Kharg Island as the focal point as its Iran's most important oil export terminal. Given the highly publicized (for military operations at least) talk, other analysts have been trying to decipher what the "real" objective might be?  I've been thinking about this myself. Fortunately, in my morning news feed is a fairly good analysis of where the US military might land. I have no idea who the author is or his qualifications, but it is well-reasoned.  His description of the doctrine:

Taking audacious risks, making the operation a media spectacle, not justifying or making the case for action or spending political capital beforehand, and letting success justify itself post hoc. Before taking the big gamble, the Trump doctrine is all about staying out of the range of the enemy whenever possible. The Trump doctrine is more conservative prior to action and shifts to being more audacious during it.  

He supports this with a look at previous Trump military adventures. The most obvious was the last bombing of Iran. Trump declared Iran's nuclear ambitions were obliterated and the mission was a resounding success.  What is lesser known about this is the agreement from both sides to allow Iran to bomb a US base in Qatar in response, AFTER US military personnel evacuated it.  

    At any rate, the author suggests a very likely target for the US is a more isolated area of Iran that is situated outside of the Strait of Hormuz, near the the Pakistan border--currently a US ally after we helped depose and jail Imran Khan the unfriendly former PM--Chabahar Bay. It's an interesting argument, and you can read the full analysis HERE.

 

 Your daily fraud take

 In relation to the insider billion dollar gains from Trump's claim of negotiations last week, the trades that were made 10-15 minutes before his announcement, this Irish, Russia-based journalist tweeted this interesting parallel to pre-Putin Russia: 

In 1990s Russia, access to power (such as the so-called "Semibankirschina" of Boris Berezovsky, Mikhail Khodorkovsky, Mikhail Fridman and friends) meant access to information. Those close to the Kremlin or state banks could see devaluations coming, understand when policy would shift, predict when borrowing would collapse or when assets were about to be handed over. They positioned accordingly and made enormous profits while ordinary Russians and the real economy got crushed. 

That was how the system worked. The same networks that benefited from insider knowledge also ended up acquiring state assets through schemes like loans-for-shares, locking in their positions for decades. Most of them still hold these assets today.  

 This reminded me of a presentation by a Russian economist in the early 2000s about Russia's economic development or lack thereof.  He described how the (mafia) oligarchs used Russian industries to syphon off for themselves. As he explained, rather than invest to expand and grow, they invested only the minimal amounts to maintain production levels.  Most of these oligarchs had ties with west, and I'd argue this is what supported Putin's rise, as he is a Russian nationalist.  He "putsched" out these corrupt oligarchs and replaced many with his own corrupt oligarchs; but at least they were now his, focused on Russian interests, not the west.  

Unfortunately, X won't let me embed the tweet, but you can find the author here: @BrianMcDonaldIE

 Propaganda 

I've argued that Q-Anon was a gigantic Psy-Op, designed to capture a significant portion of the population disaffected by the so-called two-party system.  The idea pushed by Q-Anon was Trump and his "white hats" were going to take down the Pizza Gate child-rapist empire. All of the evil democrats would be tried and hanged at Guantanamo. After Trump's loss in 2020, MAGA moved off of traditional social media spaces, creating their own like Truth Social and "underground" echo chambers on platforms like Rumble. This has essentially created a way to control the information that MAGA receives. 

    So, folks wonder, given the blatant fraud, manipulation, outright lying, why does MAGA still support this guy?  I think this video of a MAGA supporter gives the explanation as I've suggested above, as she states: 

CPAC attendee: He is the president of peace. When this gets taken care of, it's going to be peace. I'm on Truth Social, that's the only social media I do... he's got a plan. He's a genius. And we trust President Trump. 

 

Okay, that's all for today folks.

 

h/BrianMcDonaldIE/status/2037115451936039224?s=20

 

Elon Musk's (mis) understanding of economics

In this interview with Sean Hannity, Elon Musk shows his understanding of economics is not grounded in the real world.  His two main points in this clip focus on inflation and interest rates.  His explanation of inflation relates to one of Milton Friedman's old dictums: "Inflation is caused by too much money chasing too few goods".  As I used to tell my students, this says everything and nothing.  I'll address this simpleton's guide to inflation in a future post.  

Here, I want to focus on his second point, that interest rates are high because of large government deficits. As Musk suggests, if we simply lower those deficits, then interest rates will come down. The problem with this view is the evidence is extremely weak, as can be seen in the figure below.  The figure shows the relationship between government deficits as a percent of GDP (right side scale) and the 10-year US treasury interest rate (left side scale).  According to Musk, as deficits get larger (a drop in the green line here), interest rates should rise (the blue line) because "government borrowing competes with the private sector for scarce funds".  If this is the case, the lines should move in opposite directions; instead, they move (roughly) together.  For example, since 2020, deficits have declined as a share of GDP but the 10-year interest rate has been increasing.

In the economics literature, this relationship is known as crowding out, which suggests government borrowing "crowds out" private sector borrowing by causing interest rates to rise when it competes for limited funds in capital markets.  However, more often than not, larger deficits are associated with falling interest rates.  

So, why is Musk (along with many economists) wrongheaded on this point?  For one, in my view, the most important factor influencing long-term interest rates is inflation and expectations of future inflation. For example, from 2012 to 2019, the 10-year rate hovered between 2-3% because inflation hovered around 2%, and was expected to remain low.  In 2020, the Covid shock caused inflation to increase, leading to an increase in the 10-year rate.  The 10-year rate never went as high as the inflation rate, because investors expected the inflation shock was temporary, as it turned out to be.  

If inflation and expectations are the primary factor moving long-term rates, then there is a mechanism for how cutting deficits could lower the 10-year rate, but it's due to the impact deficits have on growth and inflation. As an economy grows and incomes are rising, deficits naturally fall, as tax revenues are rising. However, if a government decides to slash and burn based on a false belief "we need to balance our budgets", then these austerity measures can cause a reduction in growth, if not a recession.  This piece shows the austerity policies pushed by EU countries after the 2008 crisis "negatively affect(ed) economic performance by reducing GDP, inflation, consumption, and investment".  In other words, the main way Musk's view would be right is because cutting deficits would lead to lower growth or a recession, which would then cause inflation and interest rates to a decline.  Most inflations are tamed via recessions.

Relatedly, in this view, the impact government deficits have on long-term interest rates has more to do with how those deficits might impact inflation and not so much on the demand for scarce funds in the capital markets.  In the next post, I will explain why government deficits (mostly) have little impact on interest rates which is related to the somewhat controversial view of Modern Monetary Theory.

https://x.com/elonmusk/st9330434

https://x.com/elonmusk/status/1892443739949330434

Un-retiring...

 I retired from my academic position as of September 1, 2024.  Now that I am a man of leisure, I intend to re-activate my blog. While much of what I previously wrote focused on economics, especially the oil market, I intend to include more writing on "political" economy going forward (or left....:-), emphasis on political.  We are in strange (interesting) times in this world, and I know a majority of the population has been fed information that is designed to support the political status quo, which is designed to keep us in endless, costly wars to enrich themselves.  It will be interesting to see if Trump indeed tries to break from these entrenched interests, or if he is simply the con that many believe?

So, Happy New Year all! 

I'm looking forward to much more blogging activity in 2025.

One last "I told you so"...

While I did not formally make a prediction on oil prices this year, the same forces I've described have continued to play out: since the WTI oil market is dominated by speculators, every attempt to push prices higher ends in a collapse when inventories "unexpectedly" rise. 

In mid April, based on geopolitical issues, WTI was trending toward $70, driven by speculative bulls of course.   As inventories started rising, the bulls pulled back starting in late April.  And now, as this Wall Street Journal article suggests, oil is on the verge of a bear market, approaching $50.

Despite our president's attempt to extol the virtues of "molecules of freedom," fossil fuels, oil especially, are facing long term headwinds of green energy that will keep prices in check.  However, I doubt this will dispel the best efforts of Hedge Fund speculators to hype another oil bubble....

Good luck fellas.

It's so predictable..

Just see my last post, "Lather, rinse, repeat."  While there has been geopolitical turmoil, the Iran sanctions, the problem is STILL investors--Hedge Funds--driving prices up to quickly, beyond CURRENT fundamentals, leading to inventory builds. 

Take note: a good sell signal is when so-called "analysts" claim oil will hit $100/barrel again.  They are much like bitcoin and gold enthusiasts who need additional buyers to maintain their ponzi scheme, so they can bail and take profits...

Lather, Rinse, Repeat...

Nothing earth-shattering to report; it's the same 'ol, same 'ol....

After breaching $70--the top end of my prediction for WTI this year, we are now seeing the usual pull-back in prices which is, as usual, being driven by Hedge Funds. As it became apparent a peak was reached in mid-July (just over $74), the hedgies unloaded 178 million (paper) barrels of oil the week of July 17th (see this Reuters article). 

Adding insult to injury, this week's inventory data showed an unexpected rise: the "consensus" was a draw of about 2.5 million barrels, however inventories rose by 6.8 million, which was the third increase in the past five weeks.

As we move out of the summer driving season, I think it's safe to say WTI will remain in my predicted trading range for the remainder of the year (always with the caveat no unexpected geopolitical event occurs...).

Moving forward, I have been meaning to write some posts on the economy in general.  As I mentioned in a previous post, I expect a recession sometime in late 2019 or early 2020.  I will expand on those thoughts in the near future.

A brief Oil Market brief

Having recently just eclipsed the $70 high end of my price range, WTI appears to be receding back into range. According to a Reuters article today:

 "A sea of red is washing over the energy complex as rising U.S. production coupled with a looming relaxation in OPEC-led cuts sends bulls scurrying for the exits," said Stephen Brennock, analyst at London brokerage PVM Oil Associates.

In addition, the article notes the most recent COT report shows that Hedge Funds have decreased their long positions, which signals they believe the price rise has run its course. This belief is based on the above noted recent increases in oil output by both US shale and OPEC, specifically the Saudis and Russians are relaxing the production cuts that were put in place a year ago to help re-balance global markets.

Barring further geopolitical issues (the odds of which are getting higher that one will occur with Iran!), WTI prices should remain on the high side of my range, from $60-$70.

Trump and the Jimmy Carter Experience

WTI oil has breached the $70 mark, the high point of my 2018 range.  As with any prediction, one can't forecast "events" that influence prices. The oil market is probably the most notorious market for having political events influence significant market moves. While the fundamentals have caused prices to move above $60, the $70 breach is a consequence of Trump's decision to abrogate the Iran nuclear deal.  This was a no-brainer to predict, as Trump is so easy to manipulate, especially for a puppet master like  Netanyahu (Iran is the big prize for Neocons and Israel).

Interestingly, there was a fairly significant rise in oil inventory last week, and if today's data show another build, then prices will be pitted between the fundamentals and the geopolitics. Fundamentals will win in the long run, but the geopolitics can wreak havoc on supply in the short run. That said, Trump's decision is going to compound the economic issues surrounding his re-election bid for 2020. I've predicted (elsewhere) that his tax cuts and spending increases near the end of the business cycle will lead to a recession toward the end of 2019.  In my view, the juiced up economy will cause the Fed to raise rates faster than expected, generating a slowdown as we move into the 2020 election cycle.  However, if the decision to rescind the Iran deal maintains oil prices above $70, higher gasoline prices will take a bite out of the tax cut stimulus.

One way (high interest rates) or another (high gas prices), the US economy is in for a slowdown when 2020 rolls around.  If this is the case, Trump might have a "Jimmy Carter experience."  In 1979, Carter appointed Paul Volcker as Chair of the Fed, and while he initially supported Volcker's policy (higher interest rates) to restrain inflation, realizing the impact would hit during the 1980 election year, he pushed Volcker to reverse policy, too late of course... 

Same as it ever was...

Been a little busy with the new semester and other work, so another quick post just to put my thoughts out there on oil prices this year.  So far, things have played out as I expected. First, there was some re-balancing in supply and demand that started last year, and inventories declined for an extended period.  The problem, and it's the same problem, the Hedgies push prices up hoping this time is for real--meaning they believe the fundamentals have changed, and they push prices into the $60-$70 range hoping they will hold there.  However, their actions create incentives for US shale to expand, and the higher prices stop the re-balancing that's needed to sustain higher prices. Instead, inventories are rising again, and prices have dropped.

For 2018, I see more volatility in prices for precisely the reason outlined above--there will be periods when Hedge Funds think markets are balanced (enough) and they bid up prices, just to have them fall back again.  I think trading will range between the low $50s and the low $70s, but most of the time WTI should trade between $55-$65.  As the US economy accelerates from the tax cuts, that will bring hope and higher prices, only to be dashed again and again...Same as it ever was, same as it ever was...

Financialization of Commodities and the Monetary Transmission Mechanism

Most of my writings on this blog relate to financialization of commodity markets. Specifically, I describe how financial traders now dominate the commodity futures markets and their decisions have the greatest impact on prices. I recently published a paper that ties these ideas to monetary policy and inflation.

I argue that financialization created a more direct influence on commodity prices through an "expectations channel." As a case study, I describe the impact QE2 had on commodity prices and measured inflation via this mechanism. As the FED cranked up QE2, inflationary expectations led investors to bet on oil and other commodities, creating a temporary bubble that popped dramatically the first week of May 2011. However, since the process was driven by investors who may (or may not) learn from their mistakes, it may have been a one-time occurrence.

The paper was published in the International Journal of Political Economy, HERE.

Evaluating my 2017 forecast

It's been awhile--I had an overwhelming semester...

There are a few articles I came across over the past two months that I want to address at some point in the next few weeks, but for now I simply wanted to review my 2017 oil price forecast.

I started the year off with a fairly conservative range of $30 to $70 for WTI oil, but as I gained more confidence in my overall assessment of the market, I tightened that range to $40 to $60 in this February 15th post.  WTI hit a low of $43 in late June, and a high of $59 November 24th.  I think it's safe to say I nailed it. 

Within the next month I will provide my forecast for 2018.  I do think there is a solid floor in the low $50 range, but more on that later.

Cowabunga and Happy Holidays!

The Political Economy of Food & Finance

It's been awhile...

Just a quick note to say my book is now available in paperback HERE.

Just to add, while it may seem that "it's the end of the world as we know it..." given hurricanes and political turmoil, WTI remains close to $50, and should stay in this range for the remainder of the year.  I will provide a more detailed update in the near future.

A quick note related to the Fire post....

I just came across this Bloomberg piece, Five Charts That Explain Crude Oil's Sudden Nosedive Toward $45, which provides some charts and data on last week's oil market panic.  The charts include a look at technical analysis, showing that WTI broke through some low measures which would cause technical traders to sell; action in the options market focused on puts with strike prices of $45 and $46; and a change in the forward price structure from contango to backwardation, which they suggests shows a move from bullish to bearish sentiment.  

It should be another interesting week. Will prices break lower, or will OPEC and Wall Street be able to defend the current low?

"Fire!"

Someone screamed "Fire!" in the oil theater, and the Hedge Funds headed for the exits.

As predicted, the weight of "pork oil" finally broke the back of Hedge Fund long bets, and some big players were forced to go defensive over the past couple of weeks. According to this piece from SeekingAlpha, Pierre Andurand liquidated much of his long oil position last week, with others followed suit, citing "stop loss" triggers and "risk management requirements." The article states that Andurand's fund is down 15.4% for the year.

As I've mentioned, Hedge Fund long bets in futures peaked at the end of February, and they were slowly declining for the past two months, but the trickle became a flood over the past two weeks. According to this Ft.com article, Managed Money positions fell by 26% the week prior to Tuesday (that's when Andurand closed his position). That scramble continued the rest of the week, leading to volatile price swings; for example, WTI experienced price moves in a 7% range yesterday.

Here's how dramatic the sentiment has changed: according to this Bloomberg.com article, some trader(s?) made a serious bet(s) yesterday (Friday 5/5) that WTI will drop below $40, as 14,000 July puts @$39 were sold, almost 20 times the number of contracts previously outstanding! The price of the option was somewhere between 15 and 20 cents per contract, so that amounts to almost a $3 million wager.

Will it pay off...?  I'll stick with my call here that WTI will stay above $40, as both OPEC and Wall Street banks will try to prevent that from happening. In addition, if the price does approach $40, it will most likely cause the bulls to jump back in, especially since inventories have declined over the past two weeks. Note, that doesn't mean the huge wager won't pay off, as the option premium will increase in value if the price does fall lower.

Now, I could be wrong on that price floor, and the condition for a price collapse is the unraveling of OPEC, which is certainly a possibility given every country's need for oil revenues.  Interesting times...

On shale hedges and oil prices

Catching up on the oil news of late....

Several recent pieces on the impact of shale producers on prices. Liam Denning's article from Bloomberg.com looks at the use of hedges by shale producers and how it's restraining OPEC's attempt to raise prices (as I've mentioned in quite a few of my previous posts).  Denning provides data that essentially confirms how shale producers use hedges to lock in prices a year out when WTI oil rises above $50 per barrel, which then puts a cap on any price run up. His conclusion:

"In other words, if shale producers can live with oil at $50 or thereabouts, then others will have to adapt themselves to that level. Moreover, if OPEC "succeeds" in pushing up price expectations with extended supply cuts, Permian producers will thank them in the only way they know how. Namely, by laying on more hedges for 2018, using the cash to produce more oil -- and thereby pulling those prices back down."

This shouldn't be news to anyone who has been following my blog.

The data provided by Denning provides some interesting information concerning the history of oil prices and the impact of financial players.  In particular, there is a figure that shows the net shorts of the swaps positions (includes options and futures) in NYMEX oil.  According to Denning, "This is a proxy for hedging activity by E&P [exploration and production] companies (which generally use swaps dealers to establish their hedging positions). The lower the number, the more oil sold short, or hedged." His explanation is consistent with what former Goldman Sachs COO [and current chief economic adviser to Trump] Gary Cohn stated about the creation of Commodity Index Funds (CIFs):

"We had clients that wanted to sell future production forward. So we had many clients that wanted to go drill oil wells, but they needed some predictability of the price of oil they were going to receive out of the well to go borrow money. They tried to enter the market and sell oil. There was no natural long in the market. The consumers are so fragmented that they don't amalgamate to a big enough position. So we actually, as a firm, came up with the idea in the early 1990s to create a long only, static investor in commodity markets. We created the commodity index where we could allow people that were willing to commit large pools of capital into the market for a very long period of time to facilitate the actual producers and allow them to be able to hedge their production forward to increase their production."

Goldman Sachs and other Wall Street banks sold CIF swaps to pension funds as a way to invest in commodities long term; however, the banks (swap dealers) then had to buy contracts on the exchange to hedge their payouts on the CIF swaps they sold. These long-term commodity investments held by pension funds allowed oil exploration firms to lock in prices over a longer time horizon to cover their investments, just as Cohn argued above.  However, the flexibility of the shale producers is changing the nature of hedging as discussed in this FT.com article:

"The number of outstanding oil contracts for delivery years into the future has plummeted on the New York Mercantile Exchange. Since 2012 open interest has declined by more than 75 per cent for benchmark West Texas Intermediate crude expiring in three or four years’ time. During the same period the entire WTI market has expanded by 40 per cent."

Shale oil producers are able to rapidly ramp up production with new rigs, and costs are sufficiently low enough that they are profitable whenever the futures price exceeds $50.  In addition, as the data show, long term hedges (3 and 4 years out) have declined significantly yet overall hedging is 40% higher.  The bottom line is the shale producers are making it nearly impossible for OPEC to raise prices through production cuts because of their ability to rapidly open new rigs, lock in prices a year out, and it is profitable for them to do so when the price of WTI exceeds $50.

The latest development, according to this Bloomberg piece, is that Hedge Funds have lost patience and have dramatically reduced their long bets on crude. As I have recently argued, the banks have been preaching patience to the Hedgies, and even though US inventories have declined the past few weeks, they simply won't stand by any longer and lose money:

Investors had been expecting prices to rise to $55 or $60 a barrel in light of the OPEC deal and prices never reached that level, Tariq Zahir, a New York-based commodity fund manager at Tyche Capital Advisors LLC, said by telephone. “You started the year with longs. They’re giving up on the trade to a certain point.”

If oil inventories continue to decline, then I am sure the Hedge Funds will be tempted back in; however, to reiterate my argument once again, prices will rise too high, too fast which will both raise supply through the shale producers' reactions and curtail demand. Oil prices will certainly stay in the range of $40 to $60 for the rest of the year.

Notes from the FT's annual global commodities summit

Last month the Financial Times hosted its Sixth Annual Commodities Summit, where industry leaders gather to discuss the state of the markets.  The mood was slightly better compared to the previous year's summit, with the consensus among oil traders being "the worst has passed." However, consistent with my own arguments, most analysts believe oil prices will remain subdued, stating the re-balancing of the market will take quite some time, despite OPEC's production cut.

Two points worth mentioning.  The first relates to longer term prices.  Traders and analysts stated that low prices have significantly curbed long-term investment which could create a supply disruption 3-4 years down the road.  Much of the current investment in production is focused on shale and existing sources rather than new discoveries, which require higher prices to cover higher overall costs. I don't have a crystal ball to forecast medium and long term prices of oil, but prices will reflect the battle over alternative energy sources: will the rapidly growing impact from renewable energy countervail the declining sources of cheap fossil fuels?  I'd bet on the former.

The second issue relates to a point I made recently: oil traders stated that the increase in prices (WTI) above $50 a barrel has decreased counter party risk.  As I argued, bankers also have an interest in maintaining higher prices in order to reduce the risk of default on their loans oil producers. According to one of the FT articles, all commodity traders/producers came under increased scrutiny by banks due to the bankruptcy filing of a commodity trading house in December:

Transmar Commodity Group filed for Chapter 11 in the US last December, owing its creditors more than $400m. Its collapse has had an impact beyond “soft” agricultural commodities such as cocoa and coffee, with leading independent oil and metals traders facing increased questions about risk and compliance from their banks.

In a competitive, non-manipulated market, I believe oil prices would fall below $40 under the current market glut; however, there are too many vested interests who support maintaining prices near the current $50 WTI crude sweet spot: if prices go too low, bankruptcy risks rise; if prices go too high, the glut will be exacerbated. It's steady as she goes for the rest of the year at least.

A final point in order to toot my horn a bit. In perusing the FT articles from this year's commodity summit, I came across an article from the previous year's summit (April 2016) with a quote that supports my central thesis which is a series of speculative bubbles created the belief that higher commodity prices were the "new normal," creating false signals for producers who expanded production into riskier projects (across all commodity products).

According to Oscar Landerretche, chairman of Chile’s state-owned copper producer Codelco,

“Things might have to get a little bit worse before it gets better,” claiming too much output had been fueled by speculators boosting the price of the metal. The Codelco chairman said the spectre of non-commercial traders was haunting markets and compared them with drug dealers, arguing funds had inflated prices during the boom years and led mining companies into risky behaviour.

Speculative influences across the commodity spectrum, initially fueled by Commodity Index Funds, created a similar response in oil and grains. Given that financial traders continue to dominate markets, the shake out is taking much longer, and is more drawn out because they will not let prices fall far enough for long enough for markets to re-balance--when a new low is perceived, speculative money pours in, which pushes prices back up before the necessary reduction in supply can occur.

Maybe oil traders are right, and the worst is past them, but the "drug dealers" in the form of Hedge Funds and ETFs will continue to haunt the markets....

The Bankers are getting worried

In my February 15th piece Strange Brews in Oil, which looked at the recent phenomenon of a price bump immediately following the EIA's weekly oil inventory announcement (positive builds for the past nine weeks), I suggested the following possible explanation:

I have another theory: Wall Street banks have billions of dollars in loans outstanding with US shale oil producers and prices at $40 or less was pushing many toward bankruptcy.  Between the banks and OPEC, these are two very powerful forces with interest in maintaining higher prices. 

Deep down, I wondered if I was being a bit "conspiratorial?" Recent news gives me more confidence in this position.  First a little contextual reminder of the current oil market situation: with global supply outpacing demand, oil inventories were reaching record highs; (so) OPEC and Russia agreed to reduce output in December; (which led to) record long futures positions held by Hedge Funds at the end of February (they have since been pared down a bit); with prices reaching the mid-$50 range, US shale producers could profitably lock into contracts a year out (they were the sellers to the Hedge Funds buying); and finally, big Wall Street banks have serious loan exposure in the US shale oil market.  Let's start there.

This MSNBC piece from January 2016 provided some detail (from a Goldman Sachs report) on the loan exposure of the banks:

Bank of America leads the list with $21.3 billion. Citigroup is next at $20.5 billion. Wells Fargo is third at $17 billion. JP Morgan Chase is at $13.8 billion. Morgan Stanley is at $4.8 billion, PNC Bank has $2.6 billion and US Bancorp is at $3.1 billion. 

How much is that, as a percentage of the bank's total loans? 

Morgan Stanley leads the way at 5%, followed by Citi at 3.3%, Bank of America at 2.4%, Wells Fargo at 1.9%, JP Morgan Chase at 1.6%, PNC at 1.3%, and US Bancorp at 1.2%.

While the Goldman report didn't list their position, the MSNBC piece quoted Goldman's CFO who said they had $10.6 billion in oil loan exposure. 

So, here's the deal: as recent articles pointed out, OPEC, while previously castigating Hedge Funds for their speculative activity, is now courting them, and they have to because the HF long positions are what's propping up oil prices, at least until last week.

It didn't take a genius to see the situation was untenable: relying on the speculative bets of Hedge Funds to maintain prices is a fool's bet. This brings me to yesterday's piece from Bloomberg.com: Citi tells investors to stop worrying and learn to love oil. Citi analysts came out with a report urging investors to take advantage of the recent price drop because the Saudi's are likely to defend the price. The article also mentioned that Goldman Sachs analysts "called for investors to be patient and said they should go, or stay, long on oil." 

Hmmm....with $30 billion in loan exposure (though I'm sure they've reduced positions some since last year), do you think there might be a little conflict of interest for Goldman and Citi? Interestingly, according to this piece by William Engdahl, banks also "support" the trading of Hedge Funds: 

Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well who speculate.

According to the data above, these four banks had a combined $50 billion loan exposure to the US oil industry last year.  This is more than enough incentive for the major players to "rig" the market. However, the Hedge Funds are getting antsy, and have started to pare down their long positions. Given their herding propensity, there is a very good chance of a market rout, which is why the big banks are now publicly urging them to "hang in there." 

The current oil market situation is akin to the prisoners dilemma of Game Theory: it's in the best interest of all to collaborate and maintain higher prices (HFs benefit because falling prices will cause significant losses on their long bets); however, individual HFs may view their best option is to run for the exits (to minimize their losses) before an expected crash.  I'm thinking the exit run is going to win out...

The Pop!

After weeks of continued inventory gains, oil prices finally succumbed to the weight of pork oil.  The EIA inventory report showed a crude increase of 8.2 million barrels and prices promptly dropped on the news.  WTI crude declined by $4 (7.5%) over the next two days, with most of the loss coming on the day of the inventory news.

A good piece from FT.com highlights the main issue, the significant long bets of Hedge Funds as captured in the Commitment of Traders category "Managed Money Traders." Even though OPEC and Russia have agreed to limit output, the dominance of money managers in price determination pushed prices high enough for US shale drillers to lock in prices out along the futures price curve.  As the FT article points out, the number of shale rigs has nearly doubled since last May.  This puts everyone else in a tight spot, as it's in everyone's interest to keep prices from tanking.  The Hedgies now have to protect their long bets, and they are most likely doing so through option contracts on WTI, which experienced its second highest volume ever, according to this Bloomberg.com article.

Bad news for investors and producers, however, is good news for we consumers.  I expect the vested interests will continue to try to prevent prices from collapsing, so prices will probably fall a bit more, but they will resist at $40.

Quick update on yesterday's post

An article on Bloomberg.com this morning highlights most of the issues I discussed in yesterday's post: Hedge Funds with historic levels of long positions; OPEC's attempt to rein in supply; prices stuck in a range of $53 +/- $2--something's got to give!

The hope of the speculative long positions is that the production cuts will balance current supply with current demand; however, if supply is not curtailed significantly enough to start a draw down on the glut of inventory, then the overhang will persist, keeping a lid on prices for the next year.  And, even if prices are pushed up higher, US producers will jump in quick, adding new rigs and simultaneously selling futures to hedge production for the next year.  There simply isn't a sufficient basis of support for the bulls in the short run.

Strange Brews in Oil

I've been trying to write about other markets, but oil just keeps pulling me back.  The price of WTI oil has traded above $50/barrel since the OPEC-Russia production agreement in early December last year.  However, despite the attempt to cut production and stabilize prices, global oil inventories have continued to rise. Global inventory (OECD countries) stocks are at an all-time high no matter how one measures them.  OECD stocks currently stand at 3.1 billion barrels and US privately held inventory is at 508 million barrels. An article from OilPrice.com, Why sub $50 oil is more likely than $70 oil, looks at comparative measures of inventory, and no matter which way you slice it, the world is drowning in oil.

As I previously argued, there are two actions taken by investors who dominate futures markets (and price determination) that will maintain the current glut of oil inventory and its persistent anchor to higher prices: first, they do not allow prices to fall to a level that will restore balance via a significant shake out of producers because they tend to pile right back in and make bets on rising prices when oil prices fall significantly--a price drop creates a good "buying opportunity;" second, the stories of "peak oil" and rising demand from China, which provided the foundation for the price peak of $140/barrel in 2008, have left a persistent hangover, a belief that prices WILL again reach those levels at some point in the near future, therefore any news that provides ammunition for the bulls creates a flood of buying, pushing prices up too quickly.

Given the continuous rise in inventory one would expect a sharp pull-back in prices any day now, however there appears to be a new force or player in the market preventing the drop.  An article in the Financial Times this morning, "In oil mystery, traders resort to 'buy the build' mantra," discusses a market phenomenon that has occurred for the past few months:

Over the last five reports US commercial crude oil stocks rose by a total of 29.6m barrels. Each weekly rise surpassed expectations. While declining immediately after each report, the price of the West Texas Intermediate oil benchmark was trading higher 20 minutes later, often accompanied by a burst of volume. WTI prices also settled higher after four of the past five releases.

This morning's EIA inventory report created a similar reaction.  The report is published at 10:30 a.m. (EST) and showed another build of 9.6 million barrels, pushing US private crude stocks up to 518 million barrels. The reaction at 10:30 was a slight drop of 10 cents per barrel; however, 25 minutes later, the price was pushed up by 40 cents to $53.41(it is currently trading close to $53).  As the FT article points out, these actions have many market traders wondering who is behind the push to keep prices afloat?  From the piece, suggested suspects:

1. Hedge Funds who hold record long positions need a burst up before they can exit without taking serious losses.
2. OPEC who has cut production and needs higher prices to support budgetary needs of various countries.
3. The possibility that the behavior has influenced other traders to follow the strategy.

I have another theory: Wall Street banks have billions of dollars in loans outstanding with US shale oil producers and prices at $40 or less was pushing many toward bankruptcy.  Between the banks and OPEC, these are two very powerful forces with interest in maintaining higher prices.  However, despite the interest in maintaining higher prices, it will not stand.  While the EIA estimates that current demand and current production will come into balance sometime in the second quarter, the pressure from oil inventories will break the market at some point.  Currently, the one-year forward rate for WTI oil is $2 higher than the spot price of $53, which is not high enough to cover storage costs.  The price drop, then, will come from either Hedge Funds bailing on their historically high long positions or holders of storage, unwilling to carry inventory at a loss, selling off their stocks. Most likely the two forces will reinforce each other.

The bottom line: there is no change in my 2017 forecast that prices will not fall below $30 nor will they rise above $70.  In fact, I believe we can tighten that range to a minimum of $40 and maximum of $60, though the chances are better they will hit the low range (very soon!) rather than the high. While it's possible the price will drop below $40, any price drop of that magnitude will simply offer the bulls another opportunity to jump back in.  The more interesting story is the long term outlook and alternative energy's impact on oil, but that's a story for another day...