The 40% drop in oil prices over the past 6 months has garnered a lot of attention recently, most of it focused on the economic stimulus lower oil prices should provide the global economy, the impact on currency and fixed-income markets and the increase in economic pain suffered by exporters such as Iran and Russia. In this article, I draw on historical data to assess the potential increase in geopolitical tail risk that lower oil prices may represent. I believe this is an overlooked consequence of lower oil prices that, while low probability, would have an outsize impact on the global economy - a classic "fattening of the tail". I look at monthly and aggregate data to smooth out daily fluctuations and avoid having us mistake the forest for the trees.
The data shows that in the 1980s, the most-cited oil price war, the average price of oil dropped from approximately $28/barrel in 1985 to a low of $11.58/barrel in July 1986 (US Energy Information Administration data for monthly average front month futures contract price). This would be analogous to a drop from $60/barrel to $25/barrel in 2014 prices, using the US Bureau of Labor Statistics CPI calculator. Prices subsequently rebounded almost 60% from that July 1986 low, ranging between $16/barrel and $20/barrel for the rest of the 1980s. (There were a few months in that 4 year timespan where the average dropped below $15/barrel, but I want to focus on the big picture in this article.) Inflation-adjusted to 2014 price levels, oil prices ranged between $29/barrel and $37/barrel.
Then something dramatic happened. Between July 1990 and October 1990, prices nearly doubled from approximately $18.50/barrel to $36/barrel. You have probably deduced by now that this was when Iraq invaded Kuwait. For the next 3 years, $20/barrel went from being a ceiling for oil prices to being a floor. Subsequently, prices dropped in the rest of the 1990s until doubling and then tripling in the 2000s for reasons that are beyond the scope of this article.
Fast forward 25 years and we are again seemingly in the middle of a price war with no bottom in sight. This time, though, it may indeed be different. It would be foolish to assume the Russians do not remember the impact of the 1980s oil price collapse on the Soviet Union, then one of the largest producers in the world. At over 10 million barrels per day, Russia today rivals Saudi Arabia in terms of production, with each country representing approximately 10% of global supply. Iranian oil exports, which had only just begun to recover thanks to the loosening of sanctions, are now being hit by lower prices. At 2+ million bpd of exports, a $40/barrel drop in price means Iran is "losing" over $25 billion/year in badly-needed revenue. This is not small potatoes for a country whose GDP the World Bank estimated was only $366 billion in 2013.
Note that both Russia and Iran have shown a willingness to act unilaterally at great cost. From annexing Crimea to visibly increasing bomber patrols in Northern Europe and the US Gulf Coast, the Russians have proven they are no wilting flowers. Indeed, some would say they rely on European dependence on Russian natural gas to get their way. The Iranians have consistently refused to actually dismantle existing nuclear facilities. There has been a great deal of talk about talking, but centrifuges continue to spin.
It does not take a rocket scientist to deduce that any increase in geopolitical instability which increases the price of oil benefits Russia and Iran. It is worth pondering the implications of that statement. I am emphatically not stating that the two countries will act irresponsibly to raise the price of oil. I am just pointing out that, for both countries, lower oil prices may have subtly shifted their calculus and their thinking around the risk-reward of their actions.
We do not need to ascribe nefarious intentions to large oil producers to understand how low prices can have significant geopolitical impacts. Smaller producers such as Venezuela and Nigeria, battling social instability at home, are being hit hard too. As much as the two countries may seem removed from mainstream Western consciousness, the world does not need a new source of volatility in Latin America or increased volatility in a West African region already grappling with Islamic militancy. Lower oil revenues do not help the Nigerian army, guardians of millions of barrels per day of light sweet oil, to procure weapons and train troops to combat secessionists and Islamic militants.
Of course, prices may drop another $30/barrel. The broader point of this article is that lower oil prices have potentially "fattened the tail" by altering probabilities, risk-reward calculations and, as the global economy adjusts to lower prices, the impact of an increase in the price of oil from here. Wearing my trading and portfolio management hat, I personally would not buy oil futures or even outright buy long-dated calls. The probabilities, in my mind, are not high enough to justify the potential losses. But I have begun looking at low-cost, high-payoff options structures such as vertical call spreads and butterflies to see if they make sense as tail hedges in a potentially more geopolitically volatile world. Note that these are not trading recommendations in any way, shape or form. Just a way of articulating my thoughts.
So, is cheap oil too much of a good thing? In terms of raw numbers, it is a very good thing. In terms of fat tails, perhaps not.


hope what you're sayin' is what the kleptos wrought will hasten their demise.
I wish my wife's essential oils would drop in price.
Fracking her dry isn't what its cracked up to be?
Cheap Oil: Too Much Of A Good Thing?
Gosh......I wish they would force me to pay more taxes.
Its fine.. Putin will fix everything ... http://hedgeaccordingly.com/2014/12/moscow-no-putin-doesnt-know-how-to-f...
I wish my wife's essential oils would drop in price... that shit is expensive.
dotera=253, yeaaaaaa, enuf already...
fucking lavendar freaks, ha...
I'm still not driving a single mile more than when the price was $3.96. The extra money goes to the Obama policy the fools just doubled. So more from private industry to public plunderers. Lot of good that will do.
I try to drive less. It drives the state politicians mad with their new transportation tax schemes. Every tax those "conservatives" pass collects less.
It's no perfect world because cause and effect is always there and when we add in political gamemanship things become unpredictable. Nobody in DC or Wall St. are gaming this out long term. We are going to wind up with an entropic situation where it all goes to hell with everybody pointing fingers at each other while the world burns.
An exothermic situation.
extremely...
Oil, debased currencies, off-shored production, currency wars, 100's of Trillions in derivatives, collapsing social systems and cultures.
Yup, oil can be a fat tail because it is the #1 critical element for food production to support the current population numbers worldwide. Throw in the other things, and you have a shit-storm and "population event" one way or another.
A real liquidity trap
Ppl need to start drinking oil instead of water.
2.5 years since getting rid of my car. 2.5 years riding my bike around Denver. Still don't know if I'll go back to driving, a lot of money for a brief convenience.
Good for you, mate. Owning a car has always been an expensive necessity in England, and is even more so now at £1.20 a litre.
I haven't owned a motor since I sold my last one in 2006. I now live in an area with cheap public transport and taxis, I walk 40 minutes - 3 times a week - to the shops so save £40/month on gym fees. If my shopping's heavy I take a taxi back, otherwise the extra few pounds in my backpack strengthens my back and legs.
Every year I'd spend about £300 on maintenance and £400 on insurance, I bought 6/7 cars in 15 years of driving, all second hand, and spent around £10,000, net, after selling them. Petrol costs - no idea but they ate into my disposable income several times a week.
Since not owning a car I must have saved thousands, even taking into account the fact I need to use taxis, buses, trains and new shoes, plus I'm fitter and don't go out shopping because I'm bored and the car keys were within reach. I'll get a car when I'm too old to walk so far, maybe in 15 years. In that time I'd have saved enough to buy a Merc or Audi, cash, and it'll last another 10 years. Makes sense when you look at it logically and without unnecesary emotive reactions.
Exactly, I can ride my bike or walk anywhere within Denver in approx. 40 minutes time, I live about 1 mile from the shops. I don't buy new things for myself beyond food, booze, and dog food, so I have no need to go other places. Even ride my bike carrying 30lbs of dog food on my back.
Cars, $75 USD for gas, $115/insurance, $500/maintance, $1000/tickets (parking), plus the out right cost of cars anymore here in the US, most start around $30,000 for a car of value, so add in another $500-$800 car payment. I spent $300 dollars on a nice pedal bike and haven't really looked back since. Bit rough in the winters, but I will take a cab if it's terribly bad outside, or just stay in.
I agree, good to stay healthy and in shape as much as we can while we can.
A good bike pedal, saddle, handlebars, and tires will take you a long long way in good comfort. I'm scared of bikes ever since my dong didn't work for a week at the peak of my road cycling enthusiasm (200 miles a week in hills). Fuck road bikes, I got my skateboard bitchez. If I'm riding a bike again, it's gonna have a fat couch-like saddle.
Yeah, the wear and tear on the nether regions can be demanding. I used to do about the same, 200 miles a week, but for a lot of it I was out of the saddle. Wider saddles tended to chaff my legs but you can get racing saddles with plenty of room for your bollocks. Best get your bike fitted to your size at a good dealership, although they just measure your legs, arms, and torso and not your schlong (unless you're into that, I didn't ask and he wasn't my type! lol).
Bajpai is an awesome name
No it's not.
I don't know shit about oil but it's becoming apparent over the past two weeks, from both mainstream and alternative media, that nobody else knows either
The only observables to me are:
1. everyone and their mothers are speculating oil might drop to [insert random number here], but of course, nobody knows for sure
2. everyone and their mothers are also waiting on the start line, runner ready and mittens on hand, all waiting to catch that falling oil. you can smell the palpable anticipation in the air
3. the only thing that's obvious on the historic charts for oil is that it's always overbought and oversold, hence everyone and their mothers are speculating on further drops whilst waiting to catch it...
4. every major price shock(up or down) in the past has happened on the back of major world events or drastic action from one of the oil majors(whether it's a world-event driven shock to real supply/demand, or a world-event induced mass financial speculation on price is another discussion) - so far, we are missing the major world event to justify a deeper drop in oil. If we are expecting it to drop further, will we see it develop with Russia?
5. your mother's theories on the price of oil is likely to be just as valid as any pundit's(or your own), so you might as well ask her too. I'm already planning to ask my mum over pre-xmas family dinner this weekend, maybe she'll enlighten me(or not).
I like to pay $30 to fill my gas tank.
Many Zero Hedgers prefer to pay $60.
Mobil, Shell and the others should accommodate them.
Too much oil on the market, so the high cost producer needs to be forced out. We are in the process of finding out who that is. Enjoy the low prices while they last.
Cheap oil is a very good thing. No question about it. Its the only good thing to happen to "the man on the street" in a long long time. Enjoy it...
If oil is cheap, why is gas so expensive?
$2.06 a gallon in the Centennial State.
And I'm now filling my second 300-gallon tank behind the barn. I'm sort of a gas stacker.
Its the only good thing to happen to "the man on the street" in a long long time. Enjoy it...
Yeah.....but I'm worried about the bankers.....what's to become of them?
its like end of the long party
vodka everywhere but nobody is drinking
To test the question if lower oil prices are a good thing or not, ask what would the economic effects be should oil jump by 10x to $1,000/bbl. The problem is that it is easy to see concentrated effects such as the number of jobs of people employed in energy, but it is hard to see the greater diffuse effect of hundreds of millions of households having higher energy costs. There is also no accounting for economic effects that will come when people who used to work in energy find work in other sectors.
...There is also no accounting for economic effects that will come when people who used to work in energy find work in other sectors. -- ProLiberty
What other sectors?
It's good for consumer except ones who work in the industry. But disruptive price moves, up or down are usually not sustainable. We will see and I don't think it will be long
The question is-- good or bad for whom?
First off, it is good for the average customer worldwide. But people say that it will not last and prices will go back up once the frackers are destroyed.
Which leads to my second point. Fracking has now established a top for conventional oil. As soon as it goes up to price point X, fracking will get going again and beat the price back down due to the increase in supply.
Next, fracking technology gets better and cheaper every year. This means that the break-even point for fracking will also drop and impose a lower lid on top oil as the years go by.
Of course this process will not continue indefinitely, but it will continue long enough to seriously damage the petro-kleptocracies that depend on what was a previously balanced revenue stream to feed their many ambitions.
Yet every petro-kleptocracy on the planet is now burning FX at a frantic rate and checking the couch cushions. Fracking was not so much a technological revolution but a political revolution that has upended the global balance of power. It will be a long time until a new balance emerges and much chaos will ensue before that time.
Meanwhile, consumer societies will benefit at the expense of producers. This makes the US, China, Japan and the EU geopolitical beneficiaries and Russia, Venezuela, Nigeria, the Middle East, and probably Canada big losers. People might argue that US frackers are losers as well. This is true, but fracking comprises a very small slice of the US economy in comparison to the oil industry in the Petro-Ks.
Finally, the collapse of a static oil supply delivery system creates further instabilities. Russia, for example, is running a bet that it can bring China online before its EU business tanks due to construction of LP shipping terminals. Its monopoly in Europe is nearly at an end and its customers are racing to drive a stake into the still-beating heart.
Russia will still sell gas in Europe but as a competitive entity and no longer as a monopoly. The same will be true of deliveries to China, which has a geopolitical interest in maintaining its client states in South America and Africa. Nor is the drilling in the South China Sea to be discounted either.
Just as the steam engine and the assembly line changed the world, so too is fracking having the same effect on the established order of today. It should also be kept in mind that renewable energy sources are currently hung up on a single engineering problem-- the ability to store energy until it is needed. Battery technology breakthroughs cannot be planned for but it needs to be recognized that they will come.
The bottom line is that nations which depend on oil revenues for a majority of government revenue and spending are ultimately doomed. Can they adapt or will they go down with flags flying?
Or Saudi takes 1 million barrels per day off the market, without announcing it.
the alaska state budget, which is 90 % dependent on oil taxes
is going to take a hard hit, heard a 3 bil deficit number
thinking it could be more like a 5 bil state budget deficit for 2015....
most of the budget numbers were run with 70 $ oil...
tough times on the tundra...
Holy Hell, what do they spend their money on? There isn't that many people up there. Alberta is expecting ~$6 Billion deficit, but they have quite a bit more population.
I you want to build a house of cards from scratch, exactly how you want it, and there's already one standing, precariously, then it's logical to take that down first.
I think we are seeing an attempt to do this. I think it's part of that deal of the Oilsheiks and the Oligarchs of the west. They're in control and they're taking it down.
The whole damn thing. And remain standing themselves.
When I've had too much, I'll letcha know!
Last week, I filled up a 28 gallon tank with premium grade gas requirement. Loving it. I remember back in 2008, it would run me $130- $140 to fill a 1/4 empty tank (Ohio). People in line would throw a climate shit fit. Told them, I was just refueling my toyota prius.
http://fuelgaugereport.aaa.com/states/south%20carolina/
Texas is a massive source of federal revenue, near the top of the list and if protracted, the oil price collapse will reduce those revenues substantially. The US isn't immune to the effects and the people in cities where cars aren't predominate transportation will feel it too but they just don't understand how yet.