Energy Markets: Gauging the Risk

Let's say you are a prince sitting on a giant pool of oil marketed by cartel. The accumulation of capital that resulted from manipulation of the commodity into an inflated, non-free-market price has deflated the demand, which also "puts" deflationary pressure on the price. What are you going to do to support the price and hedge the risk against the rate of subsitution?

The prince sees a whipsaw in the making: high prices, largely the result of speculative demand of a consolidated capital (the great recession), are reducing the fundamental demand with a concommittant deflationary trend that will not be fundamentally reversed without a deconsolidation of the capital--not likely to happen--and support of the rate of substitution at the same time.

The prince's predicament, the result of a non-free-market organizational technology, is the result of incurring (creating) a gamma risk.

The risk to be managed is rendered political. It is not the alpha and beta risk that occurs with the organization of economic fundamentals in a free-market system.

Organizing to command the price has externalities to be managed politically, so the prince is likely to say... political policies designed to support the long-term rate of substitution (despite the deflationary pressure on the price) is inimical to the short-term self-interest of consumers because it hacks me off.

The threat here, of course, is purely political (organizational), and the risk to both consumers and producers is gamma.

Ironically, the prince makes the case for organizing a free-market economy, and ensuring it, in priority, obviating the probability for gamma-risk distortions that make markets fundamentally unpredictable, resulting in maximum probability for conflict resolution instead of the peaceful, stabilizing process of a free-market legitimacy.

(more at griffithlighton.blogspot.com)

The gamma risk demands management of equal measure. (The type of risk-management is "demanded," as opposed to commanded, because there is still a "choice" that can be made.)

The cartel can be dismantled to operate without gamma risk (free market economics), but that requires a deconsolidation of the capital and giving up the ability to command the price despite economic fundamentals.

Since being in command not only controls the determinants of the fundamentals, but also makes you lots of money by command (by hedging, or magnifying the profit margin) within speculative, derivative markets, the detriment of organized deconsolidation would be equally magnified.

The only choice is to maintain the gamma risk. The alternative is to effectively pluralize the system and allow the price to increase on the fundamental demand (not on command). The rate of substitution (and the profit margin) will "freely" emerge as a measure of fundamental economic reality, not the unpredictable trends of arbitrary command and control that consolidates the capital into the hands of a few players that predict the trends, and profit, by causing them.

There is no better way to effectively gauge the risk to you if you are organized to cause it and, thereby, effectively manage it.