What explains this heightened volatility in oil prices? The short answer is the death of OPEC. The U.S. geopolitical deleveraging out of the Middle East has created a disequilibrium, with Iran and Saudi Arabia engaged in a competition for regional hegemony. This competition is unlike anything investors have seen in the Middle East because it takes place in the context of global multipolarity. The U.S. is no longer willing to expend increasingly scarce resources to micromanage the Middle East and no other power is going to step in to fill the vacuum. OPEC cannot survive in this environment because a cartel cannot be maintained when its members are openly at war with each other.
How important is the death of OPEC for oil prices? My colleague Robert Ryan, Chief Strategist of BCA's Commodity Energy Strategy, and I think that it is transformative. In our joint report - titled End Of An Era For Oil And The Middle East - we argue that the salient feature of the global oil market for the past 85 years has been coordinated control of production. Oil markets will see truly free-market pricing for the first time since 1930, when amidst a chaotic free-for-all spawned by the boom in oil the Texas Railroad Commission began pro-rating production in the state to control prices.
In addition to free-market pricing, oil prices are also no longer directly proportional to geopolitical risks in the Middle East. Geopolitics will now fatten both the left and right tails of the oil price probability distribution curve (Chart). Gone are the days when geopolitics of the Middle East played an obvious, unidirectional role that simply raised the risk premium on oil prices. The new paradigm, one of disequilibrium, will create headwinds and tailwinds to oil prices (Box).
Geopolitical And Economic Paradigm Shift Fattens The Tails
New Paradigm: Geopolitical Risks Are Both A Headwind And A Tailwind To Oil Prices
This is a novel dynamic that investors are unfamiliar with. Making sense of the new paradigm will require fleet-of-foot geopolitical analysis and an astute read of the strategies of the two main players: Saudi Arabia and Iran.
So why is volatility bad news? Because simple narratives are in high demand and the media is more than willing to supply them. When the last time anyone read a piece of financial journalism that was ambivalent about the direction of oil prices? That said, investors should not fear volatility. As with any other real world outcome, the new paradigm will produce winners and losers, and thus plenty of investment opportunities.
Related podcast interview:
Dr. Woody Brock: How Shale Collapsed the OPEC Cartel and Why It Will Lead to Chaos
http://feedproxy.google.com/~r/fso/~3/NHdWSczU38k/bad-news-about-oil-prices
