Editors' pick: Originally published Feb. 1.
For many years, the price of oil has been propped up by the OPEC cartel. A revolution occurred, however, where fracking technology began to generate huge oil sources from new markets, mainly in the U.S. -- that is, from a player outside of the cartel and not one that was ever going to cooperate with the cartel. This is a generational, cartel-breaking event for an asset that has global significance and not just for the energy industry, but for all of us.
Much of what "game theory" tells us about cartels and oligopolies has been shown to be true as the fracking revolution broke the OPEC cartel. OPEC had a choice -- either lose market share and preserve price by cutting supply as other producers came online, or try to keep market share by maintaining supply, even as prices crashed, making the whole business less profitable. The Saudis and other OPEC members had the advantage in that the cost of extracting oil via fracking is higher than from Saudi oil wells, so OPEC figured if it allowed prices to fall far enough, it would put the frackers out of business.
But OPEC did not fully factor in the power of markets once let loose. The collapse in oil prices has taken on its own life and is now so dramatic that is has a wide range of implications (Brent crude traded at $90-to-$100 per barrel for about the last decade and is now down to about $35). First, the frackers were never going to give up so easily. Yes, many have been hurt (particularly those that were over-levered), but many are making sure they keep their businesses ticking by cutting costs to the bone. They are not, after all, just going to let the OPEC cartel enjoy oil profits again when and if prices rebound.
And look at the roiling markets: This fall in oil prices is indeed creating waves. Big commodity investors are suffering badly (and it has had a contagion effect on the prices of other commodities). Countries such as Russia or Venezuala, whose economies are heavily oil-dependent are being very badly affected. This itself can create a string of sovereign credit crises -- not good.
Still, I remain of the view that a dramatic decline in the price of oil is fundamentally good for us, certainly in the OECD -- it is good for most corporations' costs and most consumers. Also reducing the dependence of the world on Middle Eastern oil is a very positive thing given the instability and lack of accountability of most Middle Eastern regimes. Middle Eastern oil has been a clear source of terrorist funding and over time this source will hopefully dwindle.
But, in truth, much of our modern economies in the OECD are filled with cartels, even when we do not call them such. The general principal of U.S. anti-trust or EU Competition law that no one entity should have more than 25% share of a given market does not really work. Four players in a sector is not enough to stop oligopolistic type patterns of behavior. In addition, there is a central contradiction at the heart of capitalism when it comes to the whole issue of monopolies and oligopolies. Rational market theorists want to tell us that an open, competitive market will produce rational price levels for assets. But, actually, in highly competitive, close to perfectly competitive markets, there is very little money to be made. So your average capitalist always seeks monopoly and oligopoly -- capitalism just doesn't work to create business incentives if at least the possibility of dominating or cornering your market is not there.
In fact, it would be quite pleasant if many of our other oligopolies were broken and we reverted to a purer form of capitalism. It would be like a sort of alternative (or perhaps slightly libertarian) form of the Biblical concept of the Jubilee. Under that antique concept every seven years the economic playing field was re-set -- all debts were forgone and debtor/creditor relationships leveled, and then everyone could aggressively revert (on an equal footing) to the free enterprise game again.
Jeremy Josse is the author of Dinosaur Derivatives and Other Trades, an alternative take on financial philosophy and theory (published by Wiley & Co). He is also a Managing Director and Head of the Financial Institutions Group at Sterne Agee CRT in New York. Josse is a visiting researcher in finance at Sy Syms business school in New York.
The views and opinions expressed herein are those of the author and do not necessarily reflect the views of CRT Capital Group LLC, its affiliates, or its employees. Josse has no position in the stocks mentioned in this article.