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What Was Behind The Strategic Oil Reserve Release?

Posted by Larry Doyle on June 24, 2011 7:58 AM |

Lisa Benson captures the opinion of many as to just why the Obama administration moved to release strategic oil reserves.

Political Cartoons by Lisa Benson

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

 

  • LD: RECOMMENDED

    Thanks to a reader for sharing this commentary put forth by Mohamed El-Erian,

    El-Erian: On governments as portfolio managers
    Posted by Guest writer on Jun 23 17:12.

    From the ranks of FT Alphaville’s own AAA-list comes Mohamed El-Erian with a post about the three phases of governments’ involvement in global markets since the crisis.

    ————

    Understandably, energy markets are focusing intensely on the price impact — now and down the road — of today’s IEA decision to release 60 million barrels from member governments’ precautionary stockpile. And with oil prices down sharply, other markets are naturally paying attention.

    The IEA surprise announcement raises many interesting questions. Is this a one off decision? Are IEA members targeting a specific price level? How will oil producers react?

    In addition to these important questions, there is another element that is intriguing and warrants attention. The IEA action is yet another example of governments (and central banks) getting pulled deeper into markets as portfolio managers, as opposed to regulators and supervisors.

    This phenomenon has been very visible since the collapse of Lehman in September 2008. And it has gone through three distinct phases.

    In the first phase (end of 2008 and all of 2009), policymakers intervened in markets with the objective of overcoming severe market failures and restoring normal functioning to highly disrupted, and in some cases paralyzed, markets. They succeeded, albeit at a significant cost in terms of shifting private sector liabilities to the balance sheets of the public sector.

    The intervention in the second phase morphed. As detailed by Chairman Bernanke in his August 2010 Jackson Hole speech, the objective became more ambitious. It was to raise asset prices in order to energize private sector spending, economic activity and employment creation.

    The intervention worked in generating a broad-based surge in asset valuations; but it failed to deliver a sustainable economic outcome. As an example, just witness yesterday’s unfavorable revisions by the Federal Reserve to its growth and employment projections for both 2011 and 2012. This was just the latest example of a series of downward revisions.

    The intervention also slipped in another way: it delivered two types of asset price inflation rather than one: What the authorities regard as “good inflation” (higher bond and equity prices) that, in theory, provides a tailwind for investment and consumption; and “bad inflation” (such as higher commodity prices) that drive up production costs and take income away from consumers.

    Now, we are in phase three where policymakers try to differentiate between good and bad inflation – namely, enhancing the former and countering the latter.

    This explains the decision by IEA member governments to release supplies into the market in order to lower oil prices. It also speaks to several other actions, including the repeated hiking of margin requirements for certain commodities.

    It remains to be seen how durable the impact of the IEA action will be. In the meantime, markets will have to internalize yet another item to the long list of policy influences – the growing involvement of governments as portfolio managers.

    You do not need to be a disciple of Chicago’s Efficient Markets School, and I am not, to know that governments differ from private participants in many ways. Most importantly, they pursue by definition “non-commercial” objectives when they intervene in markets.

    Unless this new phase of government involvement is credibly and quickly signaled as temporary, it will alter the functioning of markets beyond the immediate impact. At the minimum, we should all expect even greater volatility; and we should pay more attention to identifying potential sources of unintended consequences.

    With this, and given what else is going on in today’s fluid global economy, it is a good time to give that seat belt an extra pull.

    ———-

    The writer is CEO and co-CIO of PIMCO.

  • Big Oil

    WSJ reports, CFTC Scrutinizes Suspicious Oil Trade Ahead of IEA Move,

    U.S. commodity regulators are examining whether word of a decision to coordinate a release of global oil stockpiles was leaked ahead of Thursday’s announcement by the International Energy Agency, according to a person familiar with the matter.

    Officials with the Commodity Futures Trading Commission as well as market participants have pointed to unusual trading in the oil-futures market before the IEA’s announcement that it would release 60 million barrels of oil, the person said.

    The CFTC is reviewing market data to find clues as to whether some traders may have received an early tip on the IEA’s plan, the person said

    The person familiar with the matter described the CFTC’s actions as a preliminary step, adding that in these kinds of cases, the regulator will often try to work with foreign regulators to determine if suspicious trading patterns originated in other countries outside of the CFTC’s jurisdiction.

    No surprise….cronyism and insider dealing. Standard operating procedures.

  • fred

    El-Erian is always a good read. Implicit and explicit government guarantees, whether accompanying Greek debt, sub-prime mortgages, the “Bernankee put” or a “$4 gas cap”, do not allow markets to price risk properly. When risk is not priced properly, it increases the probability of a 2 tail (asset bubble) risk event, exponentially.

    Using the mortgage backed securities market as an example:

    For 1-2 points, banks processed and issued mortgages that never would have been underwritten if they had to retain them in-house. Through the securitization process, banks sold these “bad mortgages” to an eager Wall Street where they were given an implicit gov’t guarantee and slapped with a AAA rating. The banks then repurchased a high percentage of these (now AAA rated), high risk securities w/o default risk (via gov’t gtd).

    Outright fraud was committed by:
    1)appraisers who substituted 3 recent sales data for replacement cost analysis to support inflated valuations, by 2)mtg processors who often required no income or asset verification, by 3) mtg underwriters who issued rate-reset mortgages that were all but certain to default upon reset and by 4)rubber stamping mtg transfer agents who approved ownership transfer w/o legally required documentation.

    As a start, banks should be required to return all the points paid by mortgagees to the taxpayer, the true risk takers, as unearned fees for service.

    In all instances of gov’t guarantees issuance “too easy” credit conditions, poor underwriting standards and a lack of due diligence are never far behind. The risk, which eventually becomes evident, is born by the taxpayer via higher taxes, higher inflation and ultimately, lower prices for assets purchased.

    Is there an inherent conflict of interest between gov’t guarantees and regulatory enforcement? In the case of the MBS meltdown, would it have even occurred w/o the existence of government guarantees?

    Where is the rage? Where is the accountability? Why is justice being masked by ignorance?

    And now, with the strategic oil reserve release, the game just goes on.

    • fred

      SPR release follow up…

      If you take the difference between the high price $127 in April and the probable price received for the oil at or near $100, the US taxpayer stands to lose around $800 million on the 30 million bbbls sold from SPR.

      Who stands to gain? The traders who sold near the highs, I wonder who they were? $800 million sounds like alot like QE3 to me, the only difference being cash for oil rather than cash for treasuries, and, it doesn’t inflate the Feds balance sheet.






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