Fake News and Real Markets

The Swiss and Insider Trading

This week – with the price of oil high, but not shockingly so – no lesser publication than The Economist ran a leader asking whether or not energy traders were in La La land. As I explain below, I’m not sure that they are. The fact that energy markets haven’t gone haywire when everything else has should be a good thing. Seen through the prism of supply and demand, the energy markets have remained, mercifully rational even if the political theater behind the crisis has not. So far, at any rate.

Accurately pricing risk is hard to do on a good day, worse after 60 or so bad ones. The first problem is simple market pattern disruption. Any prediction of future risk comes from past data, which works well in stable, predictable markets. The war with Iran has produced several cascading crises that simply haven’t happened before, shifting a prediction market to an interesting but speculative game. Tighter forecasts will only come with the time it takes to create an alternate pattern of events from which to build a model.

The next issue is perception and messaging. There is no good reason to believe that journalists or politicians are any better at speculative prediction than energy traders who have skin in the game and play in a universe where most people do. If nothing else, traders have access to real market signals along with the ability to separate those signals  from the noise. Or more to the point, the fake news.

The tension bad noise and real markets is best explained by the dictum: If you want to look smart, be a pessimist; if you want to be rich, be an optimist. Journalists and politicos want to look smart. Trader want to be rich.

Oil companies have massaged their messaging to portray an apocalyptic shock because they don’t like sanctions crimping their business.The media need to sell newspapers, and the politicians want to keep their jobs. They all see “the people” as customers. To traders, however, they are, to use Nassem Taleb’s phrase, “the Swiss” – masses of “faceless non-traders” not entitled to professional courtesies. In short, the world’s energy traders are operating on market signals they aren’t sharing with the world.

So Where’s the Shock?

Since the start of the war, we haven’t really faced a true supply disruption. Ahead of the fighting, oil production ramped up and shipping increased - which tells you something about the relationship between producers, traders and intelligence. Tankers move a lot of product cheaply, but they don’t do it fast. The last ships to make it out of the gulf before the Strait of Hormuz was closed made it to port by April 20 - getting close to two weeks ago. So we are only now looking at drawing down reserves in a market where gulf oil comes through expensive, small capacity pipelines. I’d argue that squeeze is reflected in the price.

Sixty days into this forced-error of a war, both sides need an off-ramp. It is reasonable for a trader to bet that, behind the noise of the political theatrics put on for “the Swiss”, parties are operating behind the scenes to extricate themselves from this geopolitical tar-baby without losing too much face. That doesn’t mean that an off-ramp will happen; the prediction and pricing models are into uncharted, and heavily mined, waters. If your job is to price risk, though, a re-opening the strait is a probability worth calculating.

The Gulf States that can are using over-land pipelines, so supply is tightly squeezed, but not cut off. Global producers, especially in the Western Hemisphere, are upping production. So is the UAE, free of OPEC production quotas as of this week, with production that largely bypasses the strait. Granted, that won’t help your summer travel plans, but it explains why pricing and futures – so far – has been less shock and more squeeze. I wouldn’t take too much comfort in that, this is less a hug from mom and more boa constrictor squeeze of death. Globally reserves are being drawn down, the inflationary impact will ripple through the system, and if this foolishness were settled next week, production and supply chains wouldn’t return to normal for about four to six months.

The gamble, then, is which side can withstand the pressure for longer? Tehran with it’s crippled economy and slow burning coup d’état, or Washington facing a mid-term election and mobs of financially squeezed voters?

Predict that one correctly and you really will be rich.

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