There Are No Goals Coming Out of This Market Swarm
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There Are No Goals Coming Out of This Market Swarm

by | published January 9th, 2019

Years ago, a colleague in the intelligence business coined a phrase that quickly caught on.

Swarm ball.

As the story goes, he was watching his young daughter play soccer and noticed something. Wherever the ball went, a “swarm” of kids descended upon it. The phrase became used to register a range of changes in operational environment in which attention from many quarters descended on a common interest.

The phrase took on a life of its own, becoming a shorthand of sorts for more complicated event sequences. Usually, it was meant to highlight a process, rather than the details themselves. The “swarming,” if you will, rather than the “ball” at the center of attention.

These days, I see such a process play out in other ways. Take the current mantra on global crude oil supply, for example.

It makes little difference whether the trend line for prices is moving up or down, pundits have a habit of rushing to how much oil is in the market as a crutch to explain just about everything. All the forward-looking caveats address supply as the main variable.

Unable to digest what the market is doing, the talking head “swarm” uses guesses about forward supply as a way of tempering whatever they have just said about the underlying price. Supply becomes the outlier in the argument, the external element impacting about whatever comment is being made.

It is the default, go-to restraint on what is actually said.

The boogey man in the market, if you will.

Now, supply and demand are certainly staple elements in estimating price. But very evident in the current climate is a reluctance to say anything of much value.

That’s because more of the statements coming from the tube are not simply about the market but about the ability to spin it…

The Self-Fulfilling Prophecy

In this age of computer-generated bulk trading, more money can be made by forcing the price down than by playing the actual underlying dynamics. Supply side “fears” service those running short contracts.

A short play results in a profit when the price of the underlying commodity or equity declines.

A simple example is this. The player “borrows” the underlying commodity from a broker, immediately selling it back to the market, moving back into the market later to re-buy it, and then returning it to its source. If in the interim the price has declined, the short artist makes a profit on the spread.

Of course, should the price move higher, the short loses money. And given the way it is set up – having to go back into the market to buy what has been “borrowed” – there is theoretically no limit to how much could be lost.

That makes naked shorts, those run without owning what is being shorted, among the most dangerous moves an investor can make.

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In the absence of genuine tangible indicators, “swarming” to an artificial concern over excess supply is a ready way of depressing price, that is, if others believe the argument.

The reason for this has been laid out several times here in Oil & Energy Investor…

“Paper” Barrels and “Wet” Barrels

It is found in the relationship between futures contracts in oil and the actual physical volume in trade (“paper” versus “wet” barrels). Futures traders will set their contract price on the expected cost of the next available barrel.

If that next barrel is perceived to be lower, so will the contract price. And a perceived accelerating decline in the forward barrels will accelerate the market pricing decline. To hedge risk, traders are now pegging contracts to the perceived least expensive next available barrel.

When prices reverse, the market process occurs in the opposite direction. Yet this is based on perception, not actual market prices.

Manufactured “sky is falling” prognostications benefit short players more than betting on prices rising (which has more to do with controlling available “wet” barrels).

So, what is really going on with supply?

Even when prices were moving down in the latest dip, objective projections (those not from a talking head shrilling a short-term short play) were all moving in the same direction. These are from sources like the International Energy Agency (IEA) in Paris, OPECs analytical division in Riyadh, and even the Energy Information Administration (EIA) in Washington.

All are pointing toward a fast approaching constriction in supply, hitting as early as the next quarter.

No, this is not a resurgence of “Peak Oil.”

No, there haven’t been any significant interruptions of crude oil transit anywhere in the world.

No, the geopolitical barometer has not altered course.

Nonetheless, (drum roll, please) as I predicted throughout the artificially inspired run on oil prices over much of the last six weeks, the underlying fundamentals in the oil market are once again pointing toward supply side pressures.

Throughout the pricing slide, pundits had been blowing bubbles. Those bubbles are now being popped by what is genuinely underway.

The reason is simple…

Something we can call effective supply.

Moving Away From the “Swarm”

Over two hundred years ago, Adam Smith in his seminal The Wealth of Nations had introduced the idea of “effective demand.”

A beggar may desire a coach and a team of horses, he noted, but that does not move the marker because he has no way of buying what he desires. There is no effect issuing from such demand.

We have a similar development on the supply side with oil.

There is much excess supply available in the ground and the amount in the market does vary. But there is also a ceiling on what can be moved into the market and traded.

We are seeing an example of this rolling out in one of the most prolific U.S. drilling basins: the Permian.

The amount of crude available is significant, but the infrastructure cannot handle it. Well before that network of pipes, storage, and treatment is expanded, there will be fewer producers still in business. That always allows those remaining to control production to improve prices.

Rising U.S. production is making it more difficult to move into the global market (where the price is set) by a limit in port and delivery capacity. That capacity can be expanded, but once again, this will take years to complete.

Similarly, the well-documented crises in Venezuela, Libya, Nigeria, and elsewhere have taken considerable technically available volume off the table with no prospect of it coming back in.

It is the effective supply that governs the actual price of oil, not the drive to generate short-term profits on phantom factors.

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As I write this, West Texas Intermediate (WTI), the benchmark crude rate set in New York, is above $51 a barrel, up 2.7% for the day, 8.5% for the week. Brent, the more widely used global standard set in London, is above $60, up 2.5% for the day and 7.5% for the week. WTI has moved up 20.1% and Brent has regained 19% since their most recent lows set only 10 trading sessions ago.

Some of this accelerated pricing rise is now a result of rapidly unwinding short contracts as the losses in those plays mount. Also, anecdotal evidence is emerging that more crude is being left in the ground as prospects for further pricing rises kick in.

Short contracts, and the manufactured “support” that goes with them, will always remain a part of the oil market.

But moving forward, at least for a bit, practitioners will have to make money some other way.

Sincerely,

Kent

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  1. January 17th, 2019 at 22:52 | #1

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