Strange things have been happening in oil markets of late. Classic price signals such as falling inventories, economic quagmire in the OECD and slackened growth in emerging markets all failed to quell a bull market on the way up to July, while geopolitical flashpoints, storms looming over the Gulf of Mexico, and the persistence of tight markets are failing to stop its bearish decline on the way back down. This raises a number of ‘inconvenient’ truths as to the self selecting nature of ‘fundamentals’ in play at any given time in oil markets.

During a stampeding bull market up to July 2008, traders failed to let news of sharp falls in US employment figures or weakened growth in Asia cool the market, as speculators piled into oil as a hedge against the weak dollar amid rising inflationary pressures. The longer term cause of this upward run was the fact that financial investors were convinced that tight supply-demand fundamentals could be exploited as they built up a large net long position in crude oil futures from 2004 onwards.

Every scrap of geopolitical friction was seized upon to push prices up; the hijacking of a small Japanese oil ship passing through the Gulf of Aden prompted the market to hit $117/b while intractable conflicts in Iraq and Nigeria alongside exotic statements from Libya, all supposedly served to bring supply-demand fundamentals closer together.

But just as the bull market wouldn’t let weak employment figures or dampened growth forecasts stop the oil markets meteoric rise, it is now highly unlikely that a bear market will let ‘minor’ inconveniences such as heightened contractual instability in Russia, North Africa or Central Asia, or major geopolitical flashpoints in the Caucuses between Russia and Georgia (and ‘associated’ PKK attacks on the BTC pipeline), stem its decline as investors look for safer waters on its way down.

Long standing OPEC stubbornness to increase output no longer appears to be a major problem, nor does entrenched difficulties in the Niger Delta. The fact that Evo Morales has been fighting for his political life in Bolivia as Pervez Musharraf desperately clung onto his last vestiges of power in Pakistan has barely touched the sides as the oil price slipped to $112/b.

This all points us towards our first inconvenient truth; namely, that speculation has added a sizeable chunk on the oil price in capitalising on tight market fundamentals. Given that the latest ‘price signals’ emanating from the Caucuses over the fraught existence of the BTC pipeline and access to Central Asian oil reserves that feed it, or looming storms in the Gulf of Mexico, have actually prompted the oil market to drop even further (hitting $106/b), provides unequivocal evidence that the market is currently being dictated by financial investors unwinding their net long positions to realise capital gains and release liquidity, rather than any shorter term price signals in play.

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