Thursday, July 30, 2015

Supply Data, Tragedy of the Commons

As investors await supply news from the Energy Information Administration, crude prices oscillated between gains and losses. After opening at $48.83, prices peaked at $49.33 on a decline in crude production was revealed yesterday, but as the market closes, the WTI spot seems to be settling at a loss around the $48.50 price level. Although the benchmark will most likely fail to move more than 1% in either direction, analysts will wonder why supply data had little effect on the movement. As reported by the EIA, crude production was reduced by 145,000 barrels over the past week, and this was accompanied by an announcement that the Saudi's would cut back production at the end of the summer. Nevertheless, the domestic report also noted that rig utilization decreased, but only by 0.4% still maintaining capacity as high as August of 2014. Likewise, 2015 third quarter capacity utilization remains above 95% in attempt to surpass third quarter levels in 2014 which averaged out to be 93.2%.


Any investor looks at the above chart with questions, and questions that have confusing answers. Why would 2015 utilization levels be higher than 2014 in every week for June and July when the crude price is more half what it was a year? Yes, production and inventories are showing a slow recession and that could be higher demand or the 0.4% drop in capacity drop, but despite those drops, the American oil pumping miasma refuses to allow any rigs or wells to sit dormant with the specter of windfall profits on the horizon. We've already seen the cost of operations below break-even level in earnings reports like BP, and without cuts in utilization, many companies could be functioning in the red for a while. Perhaps the problem is not individual decisions but a failure to consider group behavior. Average utilization in 2014 for June and July was 90.95% when prices were high and profits were bountiful, so why is the average utilization in 2015 for these two months almost four percent higher at 94.66%? It's the tragedy of the commons. Executives at the head of domestic oil corporations look back at oil crises in the past, especially the fresh events in 2008, and see windfall profits that came after prices rose. Individually, they make decisions with the hope that these profits will come so production is kept stable despite a smaller loss today (anticipating large gains tomorrow). Collectively, all or most oil companies will maintain production with their own interest in mind, and so the group will suffer as supply is never bottlenecked. Low prices, thus, remain despite a wave of bullish behavior that paradoxically hold them there. Knowing this, we can now understand why OPEC was so powerful. Because of their existence as a group acting in the group's interest (most of the time), they were not subject to the psychological phenomenon known as the tragedy of the commons. At the same time, each member country does not always make decisions with their best interest in mind (hence secret output). As we continue to watch this fragile market trudge about with its supply glut, the opposing motivations and decisions that are defined by group and individual identities should be observed.

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