Strange things are happening in the global oil markets. The prices, set by the oil futures market, seem to make less and less sense when compared to the underlying fundamentals. Last week, Opec+ convened a meeting at which the cartel decided to cut oil production by a total of 2.2 million barrels per day.
In normal times, this announcement would lead the price of oil to rise. After all, if the demand for a good remains unchanged and its supply decreases, basic economics would tell you that the price should rise. Not so in the oil market. After Opec+ announced its new round of production cuts, the price of oil fell from around $80 a barrel to around $74.
In response, market commentators for the most part tried to justify the decrease in price by claiming that the Opec+ production cut was not well “communicated”. But the market price for a commodity such as oil does not depend on the Opec+ public relations department — it rests on how much black liquid the cartel pumps out of the ground.
Another excuse doing the rounds was that the decrease in price was because the market did not trust Opec+ to follow through with the cuts. But this makes no sense: after the meeting there was a higher probability of greater cuts than beforehand. It is the difference between Opec+ agreeing to play a hand regardless of whether their cards are weak, or simply sitting this one out.
Gradually, smarter commentators began to suspect that something strange was going on. The day after the meeting, Bloomberg ran a column explaining how the oil market has been taken over by speculative traders and algorithmic trading. The algorithms sell oil when given specific signals, but speculative short sellers seem to have felt out the pain points at which the algorithms are activated. Now they are selling oil in huge volumes, which then triggers the algorithms, pushes prices down further and allows the speculators to profit on their large short positions. According to market research firm Bridgeton Research Group, such algorithmic bets have now reached record highs in the oil market.
Why does this matter? Although consumers benefit from cheaper oil, artificially suppressed prices have serious ramifications. If the current oil price is substantially lower than what it should be, then people will be encouraged to consume more oil. At some point, though, the supply will dwindle due to overconsumption and prices will snap back violently.
The futures market cannot pretend forever that there is more oil than there really is. In effect, it is writing contracts for barrels of oil that do not exist, thereby “printing oil”. This is completely unsustainable.
Politicians, however, could not be happier, especially Joe Biden. Among Americans, 67% disapprove of the President’s handling of the economy, and given that oil prices are a heavily politicised issue in the United States, Biden will be extremely happy with these developments. Some have speculated that his administration will use the opportunity to refill the Strategic Petroleum Reserve that it has recklessly sold off in an attempt to counteract rising energy costs.
But we cannot forget that it is Opec+ which controls the supply of oil, and the group stated clearly that it will be reducing this supply. Eventually, prices will go up again — and it is leaders like Biden who will face the consequences.