Minyan Mailbag - Crude Rumors

Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.

Scott,

I am intrigued when crude oil spikes on refinery fire rumors/news. I understand how a disruption in refining capacity would lead to higher refined product prices such as gasoline. But why would crude rise? By my reckoning, a decline in refining capacity would result in an increase in crude inventories and/or reduced demand (even if only temporary), which should result in lower crude. This is especially so in the U.S. since refining capacity is almost maxed out at current production and there are few options available to pick up the slack for refiners that go down.

Thanks and have a good weekend.

Minyan George

George,

Your logic makes perfect sense to me; a decline in crude would seem to be a rational response to a decline in refining capacity, for all of those reasons you cited.

But how do we know that crude is up because of that refinery news? Couldn’t there be other factors in the market for oil? In fact, wouldn’t you expect there to be an almost infinite number of factors at work for every single trader and institution buying and selling oil today? The answer to all three is: of course.

If there is one thing that I have learned (and only by losing lots of money) it is this: correlation does not mean causation. Just because a particular piece of news is commensurate with a price move in a security (even statistically significant ones) does not mean that that is the reason for the change. You probably already know what I think: investors who assume causality ignore the essential role that irrationality and macroscopic (read: crowd) behaviors play in negotiated financial markets. These behaviors interact in both positive and negative feedback regimes that are impacted by many factors; ‘rational’ fundamental ones like those you laid out above as well as ‘irrational’ ones like traders buying oil futures because they believe others will do the same when they hear the ‘news’. The point is, one cannot isolate any specific factor and say “that’s why oil is higher today’. The market is made up of many different actors, all with different goals and all acting on individual rational or irrational reasons.

So what’s the lesson here? It’s dangerous to trade purely on news. It’s dangerous too to assume all the other traders out there are governed by rational calculations. They aren’t.

Regards,
Scott