Oil and gas redraw world strategic alliance map

16 February 2015

When markets enter periods of volatility, it is reasonable for investors and observers to scurry about looking for the ‘cause’ (there is usually thought to be only one).

It makes for effective media grabs: ‘The Australian dollar fell today on fears of a Chinese slow down/rising American employment/The Reserve Bank’s possible lowering of interest rates/strength in the US stock market/weakness in local bank stocks/increased fears of global warming etc. etc.’

But it is almost always fallacious. Heavily traded markets do not set prices with one motive – there is no such thing as the ‘mind’ of a market -- they reflect multiple motives.

As the Nobel prize economist Eugene Fama observes, it is wise to assume that the market is efficient in the absence of a better model. At the very least it is a way to avoid two of the most common cognitive biases: illusory correlation, the often false belief that because two things occur at the same time they must be causally linked; and illusory superiority, the belief that you know better than everybody else.

The sudden, and precipitous, fall of the oil price since mid-2014 does seem to be an exception, however. It does seem to be managed. The price is down almost 60 per cent since June, causing ructions in the global energy market. It has long been manipulated by OPEC, and there is a history of manipulation of the oil market for political ends, dating back to the stagflation of the 1970s when OPEC brought on a quadrupling of the oil price.

Two motives behind the current volatility are worth entertaining, although the evidence must be considered less than conclusive. One is that it is an attempt by OPEC to weaken the high cost producers, especially those in America using fracking: the process of extracting oil or gas by injecting liquid at high pressure into fissures in the rock. For the first time since the 1950s, America has become a net exporter of some hydrocarbons, greatly reducing its dependency on Middle East supply. In 2013, US oil companies began applying to export crude oil, an unthinkable prospect before fracking technology became widespread. According to the US Energy Information Administration, American oil production rose in January to 9.21 million barrels a day, the highest level since 1983.

The problem for the American producers is that most require an oil price of about $US100 a barrel to be profitable. At the current level

ECONOMICS

Oil and gas redraw world strategic alliance map

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