LONDON (Reuters) – OPEC’s failure to reach a new agreement on production and the public sniping among ministers about who was responsible have prompted an outpouring of comment about whether the organisation is in crisis and can regain its relevance.

Discussions about the future are linked to speculation about whether the breakdown was due to narrow technical differences about forecast consumption in the second half of the year, as the secretary-general has insisted, or is part of an escalating geostrategic confrontation between Saudi Arabia and Iran that brings in the United States and Venezuela.

No one yet knows whether the meeting’s failure was due to a miscalculation on the part of Saudi Arabia or Iran — or if the breakdown actually suited the political purposes of both sides. But it has highlighted some important structural truths about where real power lies and the issues facing the organisation in the years ahead.

ONE SWING PRODUCER

OPEC is not the swing producer in the oil market. In recent years, that role has been performed almost exclusively by Saudi Arabia — to some extent in conjunction with its close allies Kuwait and the UAE. Talk about “the call on OPEC” is outdated and misleading. It is really “the call on Saudi Arabia and its allies”.

OPEC is not currently a cartel in any normal sense of the word. Cartels exist when producers in an industry with actual or potential excess capacity agree to shut in some current production and jointly plan future increases in order to raise prices. But this does not describe OPEC.

In the six years since 2005, the market has exhibited only limited amounts of spare capacity, except in the depths of the recession. Of the spare capacity that exists, almost all has been concentrated in a single country, Saudi Arabia.

LONDON (Reuters) – The modest rise in oil prices Wednesday shows the market shrugged off OPEC’s failure to reach an output agreement and ignored an unexpectedly large drawdown in bulging U.S. oil stocks.

The lack of a more aggressive response to two pieces of information most analysts would consider bullish suggests the stalemate between the bullish and bearish camps remains. Most market participants apparently did not consider either piece of news changed the outlook for supply or prices materially.

It may be tempting to write headlines and research reports suggesting prices surged higher amid the stormy breakdown of the OPEC ministers’ meeting and signs of a tightening market balance in the United States — but the data suggests otherwise and there is nothing to be gained from arguing with the tape.

STATISTICALLY INSIGNIFICANT

Front-month Brent futures rose $2 per barrel from $116.40 to $118.40 in under 10 minutes when news of the meeting’s failure broke and then traded sideways for the remainder of the session, ignoring the U.S. stock draw entirely.

Chart 1 shows the sudden price jump and the increase in volume shortly after 1311 GMT. But price moves on Wednesday were actually smaller than average, suggesting few market participants read much significance into either piece of news.

For the day as a whole, front-month futures prices moved in a range of just $2.84. Compared with an average daily range of $3.04 since the start of the year and a standard deviation of $1.83, the movement was not statistically significant at any level.

LONDON (Reuters) – OPEC’s failure to reach agreement on lifting quotas or oil production has exposed the organisation as a paper tiger. It confirms that market policy will be set unilaterally by Saudi Arabia and its allies.

It means more oil will be supplied in the coming months, not less, and if anything is moderately bearish for prices.

OPEC Secretary-General Abdullah El-Badri told reporters the effective decision was no change in policy — but that is not right. The effective outcome is to leave production decisions to Saudi Arabia and encourage an informal but substantial increase in output in the coming months outside the OPEC framework.

Even before the meeting broke down acrimoniously, the kingdom had already indicated it plans to raise output, whether or not the organisation changes official quotas and production ceilings. Saudi production will now rise, and the kingdom will probably be joined by its close allies, Kuwait and the United Arab Emirates.

The kingdom has shown a clear preference for preserving cartel unity. But unable to persuade its fellow members to agree to a big enough increase in output and ceilings to stem the upward pressure on oil prices, the kingdom seems to have decided there is less damage from going it alone than deferring to the sensibilities of other members and risking a further price increase.

The failed ministerial conference has pushed OPEC to the sidelines and will ensure oil supply decisions are made in Riyadh – unconstrained by the concerns of other cartel members. That probably means a more dovish approach that sees more barrels coming to market because Riyadh is far more concerned about the political and economic damage from soaring oil prices than Iran, Venezuela and some of the other cartel members.

Price hawks like Iran and Venezuela have overplayed their hand. Paradoxically, failure to reach a consensus means output will rise more sharply and openly in the coming months than it would have done otherwise.

LONDON (Reuters) – Fed Chairman Ben Bernanke and his colleagues on the Board of Governors are not a very talkative lot. Bernanke and the other governors are much less willing to talk to the public and media than their predecessors — particularly since the onset of the recession in 2008, and especially about issues relating to the economy and monetary silence.

The silence is almost deafening. While regional Fed presidents comment regularly on both, Fed governors have given just 5 speeches on the economy or monetary policy since the start of the year. The most recent was by Vice-Chairman Janet Yellen almost two months ago. The chairman has not spoken on the subject since February.

The attached chart shows the number of speeches given annually on various subjects by members of the board since 1997. (Click here)

I have split them roughly into monetary/economic and other categories based on the title recorded on the Fed’s website. The categorisation is obviously somewhat subjective. It does not include formal testimony to Congress including the semi-annual outlook (though that has by definition been constant).

The focus for speech-making changes over time reflecting the central bank’s preoccupations. For example in the late 1990s Fed speakers were giving dozens of speeches on the so-called millennium bug. Following the financial crisis, Fed speakers are preoccupied by prudential regulation.

Finally, the number of governors has not always been constant. At the moment only five seats on the board are occupied. Two places remain unfilled. So the number of speeches could be expected to decline somewhat in line with the reduced number of potential speakers (though the reduction would not be linear since speaking rates are variable).

But even making informal allowances for all these factors, it is notable how few speeches the current crop of governors are making, particularly on issues confronting the economy and monetary policy.

LONDON (Reuters) – Soaring food and fuel prices have become a substantial burden on households in the United States, the United Kingdom and other economies since September 2010, and may have contributed to a slowdown in growth recently.

The International Energy Agency has warned “additional increases in (oil) prices at this stage of the economic cycle risk derailing the global economic recovery” and called on producing countries to raise the supply of crude.

But leading oil forecasters are divided over whether prices have yet risen far enough to ration demand — via direct effects (substitution, conservation) and indirect ones (falling incomes, slowing growth) — or need to rise further before the market finds a fundamental and geopolitical equilibrium.

THREE KEY QUESTIONS

Three questions are critical for both the global economic outlook and prospects for the oil market:

* Does the sharp rise in oil prices since September 2010 qualify as an oil shock?

* How do oil shocks affect economic performance in the United States and elsewhere?

LONDON (Reuters) – Goldman Sachs commodity analysts Tuesday reiterated they remain “structurally bullish” about oil prices and hiked their price forecasts for the remainder of the year and into 2012.

It is all a rather abrupt reversal from the warning about short-term downside risk the same research team published on April 12, when the bank recommended clients close long positions in crude and other commodities before an expected pull back.

The gnashing of teeth from rival teams is almost audible around the market. Back in April, Barclays Capital analysts warned that calling for a temporary top in prices might appear opportunistic — guaranteeing some short term headlines and then some more when it was reversed:

“If analysis were to be judged solely in terms of the weight of headlines generated and their impact on the petroleum paparazzi, then following a route of frequent turns in a basic view might well be the best way to proceed,” a BarCap note said.

Goldman’s call for a temporary top in the bull market has been blamed by some observers as a contributing factor to the sharp selloff on May 5, as well as the elevated volatility and downward drift that persisted after. It also led to furious responses from some hedge funds and other oil bulls.

But in their defence, Goldman’s analysts can point out they only called for a temporary and tactical retreat in prices in a market that showed signs of becoming overheated, and where prices seemed to have raced ahead of fundamentals. They expected Brent prices to pull back to $105 before resuming a climb.

Front-month Brent futures have now completed the anticipated pull back, falling to just over $105 earlier this month and settling into a $105-$111 range in the past week. Having re-connected with fundamentals, in the bank’s view, and achieved the near-term target, Goldman is simply restating its belief in a rally during the balance of the year.

LONDON (Reuters) – The last and most important line of defence for central bankers and economists trying to disclaim a link between monetary policy and soaring commodity prices has been to argue that the effect is probably only temporary.

Food and fuel price increases are portrayed as a one-off adjustment in response to a series of discrete and unrepeatable shocks rather than an ongoing process of inflation that signals excess demand. While they will push up the headline rate of inflation, the effect is expected to be transitory, according to the Federal Open Market Committee.

Once food and fuel prices level off, headline inflation will converge back to the core rate. This thinking permeates the Fed’s thinking, and is central to the projections of the Bank of England. It was also recently articulated by Nobel Laureate Paul Krugman in a blog for the New York Times.

Much the same argument was used three years ago in February 2008, when then Fed Vice-Chairman Don Kohn promised that inflation would soon come down and argued, “This projection assumes that energy and other commodity prices will level out, as suggested by the futures markets.” This was before the oil market began its final ascent to $147 per barrel. here Echoing this, current Fed Vice-Chairman Janet Yellen said last month, “The current configuration of quotes on futures contracts — which can serve as a reasonable benchmark in gauging the outlook for commodity prices — suggests that these prices will roughly stabilise near current levels or even decline in some cases.”

Krugman endorsed this thinking: “The idea is that even if the recent commodity price rise is permanent, as long as it levels off it will lead only to a temporary bulge in broader inflation. And the appropriate response of the Fed is to keep calm and carry on.” here

CIRCULAR THINKING PROBLEM

But is this argument correct or an example of circular reasoning? Ignore for a moment the question about whether it is possible to extract useful predictions about future cash prices from futures contracts, which is very questionable.

LONDON (Reuters) – Inexperienced “noise” traders who follow the herd, over-react to data, and lack the financial strength and understanding to stay the course during corrections have been blamed for rising volatility in commodities.

Recent crashes in silver, crude and gasoline that seem to lack any grounding in fundamental supply and demand factors have all been blamed on naive investors who lack the financial strength to hold a position through a drawdown and stampeded for the exit at the first sign of trouble.

Perhaps the best example was the 8 percent slide in U.S. gasoline futures on May 11 after the Energy Information Administration announced gasoline stockpiles had risen 1.3 million barrels.

The stock build was enough to trigger a trading halt and caused a sharp dive in prices for crude and diesel. Yet the rise amounted to just 0.6 percent of gasoline in storage. It came after stocks had fallen more than 36.5 million barrels (15.2 percent) in a string of 11 consecutive weekly draws, pushing them down to the lowest seasonal level since 2006.

Was that a rational response to signs of a trend reversal, or an irrational over-reaction to a single data point that failed to see the bigger picture?

THE MYTH OF THE EFFICIENT MARKET

Supporters of the efficient markets approach tend to divide market participants into (1) professional insiders (who make rational decisions based on a deep understanding of fundamentals); and (2) noise traders (outsiders with little understanding who misinterpret data, over-react to news, are overly influenced by others and prone to herding).

LONDON (Reuters) – Most analysts have downplayed last week’s sudden drop in oil prices and reiterated or even raised their bullish forecasts for the remainder of the year.

But just because a sudden price crash does not appear to have a rational trigger does not mean it is safe to ignore it and assume fundamentals and therefore the price outlook have not changed.

While the flash crash may not reveal new information about physical supply and demand, it reveals quite a lot about the positioning of major market participants.

To the extent market positioning is also a fundamental determinant of prices, as most behavioural analysts believe, the flash crash should prompt analysts and investors to reassess their outlook.

In particular, the flash crash probably heralds a period of significantly increased volatility in the petroleum complex and other commodity markets.

VOLATILITY IS A FUNDAMENTAL

It is known daily price changes for crude and other commodities do not follow a normal distribution. Large price increases and falls occur far more frequently than the normal distribution allows. Price changes exhibit fat tails or excess kurtosis.

LONDON (Reuters) – Reports of massive mark-to-market losses at several large commodity-focused hedge funds during last week’s crash put a spotlight on the enormous positions being run in oil and other commodity markets.

The scale of positions revealed suggests the long side of the market may be more concentrated than a simple examination of the weekly returns from the U.S. Commodity Futures Trading Commission (CFTC) would imply.

Huge positions run by a relatively small number of commodity funds suggest the potential for enormous price volatility ahead as they try to book profits.

Big named losers in last week’s flash crash included Clive Capital, ex-Phibro head Andrew Hall’s flagship fund Astenbeck II, Blue Gold and Dutch technical fund Transtrend.

The scale of the losses — with Clive Capital reportedly losing $400 million at one point, according to the Financial Times — provides some insight into the size of the positions they are running.

HIDDEN IN PLAIN SIGHT

Prior to the crash it was already clear hedge funds and other money managers were running record speculative positions in crude and other commodities.