Drilling Laterally
Can the world still avoid an energy calamity?
“Some people don’t like change, but you need to embrace change if the alternative is disaster.” – Elon Musk
We begin with a confession. If you had told us six months ago that US President Donald Trump would launch an oil embargo on Venezuela, snatch its president, and bring him back to the US to stand trial; that Trump would collaborate with Israel to launch yet another preemptive strike against Iran, but this time with much more devastating effect; that Iran would respond by effectively closing the Strait of Hormuz, destroying numerous oil tankers, and bringing the war to every Gulf nation that houses a US military base; that the two warring sides would come perilously close to an all-out assault on the oil-producing assets of the Middle East; and that Ukraine would not only continue its assault on Russia’s energy assets but also attack oil tankers in international waters, we would have guessed that oil prices would skyrocket to much higher levels than those experienced over the past two and a half weeks.
That they haven’t is, frankly, a bit of a mystery.
Not that there aren’t some potentially plausible explanations being put forth by those long oil and hoping for prices to go higher. Perusing Twitter/X, we find two dominant conjectures. The first is that the market is simply wrong. It is mispricing the risk of escalation, underestimating the length of time the Strait will be closed, and reacting to Trump’s mercurial and erratic social media posts, which are clearly designed to keep a lid on oil prices.
The second and somewhat more far-fetched explanation is that Secretary of the Treasury Scott Bessent is manipulating the price of oil by “shorting the futures,” something members of the Trump administration have certainly jawboned as a possibility. While we freely admit that we are not experts in market structure, this sounds rather similar to “naked shorting,” “synthetic shares,” and other market ghosts that have become a common lament among disappointed investors in the post-Covid era. Do interested governments sometimes intervene in strategic markets? Almost certainly. Is Bessent primarily responsible for the comparatively docile oil price action in the face of these headlines? Consider us dubious.
Of all the markets we follow, the market for oil and its related commodities is among the most brutally efficient. Major participants tend to be incredibly sophisticated players with intelligence capabilities rivaling those of small nations, and they often reside in locations less encumbered by insider-trading laws than the average retail investor. If an edge on the market can be developed, it will be ruthlessly exploited, and less well-informed players will be swiftly separated from their money. These attributes also make the market challenging to manipulate, especially during periods of extreme volume like those we are experiencing now.
Is the market often caught offside by a sudden, unexpected headline? Sure. But this many days into the war, isn’t it safe to assume that the various escalation pathways, off-ramps, and second-order consequences are already worked into the prices we see on the screen?
This line of thinking motivated us to engage in an exercise in lateral brainstorming, where we explored the following mental model: Assume the market is right and oil prices won’t explode much higher from here, even if the war drags on. What might explain this? What might we be missing?