Publications: Notes at the Margin

Liquidity, Margin Finance Risk, and Trading Companies; Petroleum's Prolonged Existence (March 4, 2024)

 

This week, we cover two issues. First, we attribute the current insubstantial oil price volatility to an unnoticed but significant action taken by oil traders fifteen to twenty-one months ago. Second, we explain why the world will not likely reduce net global-warming gas emissions to zero by 2050.

 

We begin by noting that most energy traders suffered near-death experiences in 2022 when prices rose after Russia invaded Ukraine and counterparties and futures exchanges demanded huge daily margin payments. Total’s CEO, for example, said that, on one day, his firm was slapped with a call for eight billion dollars. Energy traders appealed to central bankers for support, who told them to see their own bankers. Now, more than a year after receiving this harsh financial lesson, the companies have restructured, building large cash reserves to withstand future crises. Their heightened risk aversion limits speculative buying, which helps moderate oil price swings. This caution could help create a new price stability.

 

Next, we discuss the energy transition, noting that transitions fall into three basic types. Those that succeed because the new process or technology offers clear cost savings. Those that fail because they do not offer cost savings, and those that succeed because governments mandate them. The latter, however, require ongoing voter support to maintain their success.

 

Many of the proposed approaches to the energy transition will not provide significant cost savings and so will fail absent government intervention. Indeed, the signs of failure are already evident.

 

Consequently, the energy transition will probably slow and will almost certainly not reach the 2050 net-zero target without massive government regulatory involvement. And given recent events, many existing mandates will be delayed or overturned.

 

Based on the current situation, oil companies and countries seeking and developing oil reserves should keep drilling. Firms that operate large, advanced refineries should continue investing in their facilities and processing oil.

 

In 1897, after hearing he was dying in poverty in London, the American humorist Mark Twain responded, “The report of my death was an exaggeration.”[i] In the same vein, the widely touted demise of petroleum—and natural gas—has been overstated.

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