The Strategic Implications of the BP Turn Off -- A Thought Experiment

This just in:

BP, based in Britain, said late on Sunday that it had begun closing the Prudhoe Bay field in Alaska after discovering a small pipeline spill in a move that will slash production by 400,000 barrels per day.

Firstly, is it possible that we purposefully turned off a large supply of oil from oil fields we control?

Well, we know an Iran-related turn off would shock the system with Surprise and Uncertainty.

But why is that important?

Surprise causes the market to become reactionary, and uncertainty increases entropy.

What do you mean, entropy?

Entropy in the sense of unpredictability. Markets thrive on foresight, and uncertainty clouds their vision. This lessens their intelligence (which is a function of the amount and accuracy of information), and they become vulnerable to vast fluctuations.

Why do they become so vulnerable?

Because confidence in predictability provides stability, and if you remove it, the system becomes unstable. We're dealing with human beings with inadequate knowledge reacting to false positives with positive feedback. It makes things unstable and vulnerable to phase shift.

What do you mean, phase shift?

The phase shift happens when the state of the system gets close to an attractor placed on a critical point. This critical point is the boundary where the state of the system, steadily being one thing, shifts directions and starts becoming something else. It's where solid becomes liquid, and it's where a system can crash. If the stock market fluctuates too far in basic commodities, commodities that hold the whole system together, then the point of criticality could be crossed and we could experience a massive flight of capital.

Like another Great Depression?

Which would then throw entropy into our everday lives, which would cause stress on our society, etc. Nobody's lived through "potential great depression of 2006" yet. Economists will try to tell you what will happen, but what they are really telling you is what has happened. Economics, like history, is a social science, capable of coughing up guiding patterns and analogies, but completely resistant to an overall ideology. The meta-ideology of pragmatism works most often, but even that has shortcomings, because sometimes things depend on being non-pragmatic. The point is that there is no formula economists can use to plug in today and derive a firm answer on what it means. And the accuracy of their analysis drops as entropy rises. The more uncertain things are, the less data mean what they "normally" mean. The more predictions that are falsified, and the greater the frequency, the higher the stress on those who move the market. The higher the stress, the greater the vulnerability.

So how does today's BP turn off fit in?

Here's how it would go. We give the system a manageable amount of hurt (8%) and the certainty of coming back online on a specific date; this allows the system to account for it and plan around it, which lowers the Uncertainty, provides Information, and holds steady the Confidence of the market. We get out ahead of any future Iran-related disruption, and provide the market with a palliative to muffle the dissonance of war. Simply: we play a card to preempt this shock, and, under cover of a manageable supply shortage, publicly declare that we have opened the strategic reserve.

And think about it: a small leak is certainly the type of excuse you could manufacture and cover up.

But why do all this to turn on the strategic reserve?

Because once the strategic reserve is on, this country is prepared to wage war. (you must read all of this):

Obviously, it would be impossible to develop a universal drawdown policy that would effectively respond to every potential oil crisis, but a set of public guidelines for multilateral action are essential. Each country has its own national drawdown policy. Each country, if not each politician within a country, moreover, has its own definition of crisis and response. The CERM provide for multilateral consultation by the 26 members of the IEA so that a coordinated, multi-lateral draw down of the members’ combined strategic reserves may take place. This consultation process, however, does not provide any hints to the marketplace or road map to the policymaker as to how and when multilateral market intervention might take place.

Market intervention is a contentious issue. Indeed, any oil disruption results in a difficult dilemma. On one hand, the price mechanism may be left alone to reallocate supplies, but a period of high prices must be endured in the interim. On the other hand, strategic oil reserves may be used to replace lost supplies and lower prices, but then the price mechanism may be short-circuited in a manner that prevents or delays the most efficient allocation of resources, leaving pockets of high prices at the end of the supply chain. The policymaker is caught between two less than optimal outcomes. Strategic reserves represent a blunt instrument whose use may spawn unintended and unwanted consequences even as they lower benchmark prices. Oil prices, however, do not manage crises; they measure crises. Excessive reliance on the market during a major oil disruption is tantamount to rolling the dice on the global economy.

War with Iran would cause a major oil disruption. We could be adjusting in advance.

So we're preparing for war?

We could be. If we are, the strategic reserve would be an important step. And this way it doesn’t cause stress on public perception and doesn’t tip our hand to the Iranians.

Why not just open the Strategic Reserve?

Besides tipping our hand? Well, that's the alternative to the conspiracy theory. But there is one hiccup in that theory, too.

What's that?

We wouldn't start drawing from our strategic reserve as a first resort:

The Gulf War was another test of emergency preparedness. Iraq’s invasion of Kuwait and the subsequent cessation of production by both countries seemed a textbook opportunity for the use of strategic stocks. Crude oil prices doubled between the third and fourth quarters of 1990 even though Saudi Arabia and other countries immediately increased production in a market that was already very well supplied prior to the August 2 invasion. The IEA, however, did not draw down strategic reserves until January 1991 and then only as a complement to the start of the air war over Iraq. The Contingency Plan used was designed to increase “supplies” by as much as 2.5 million b/d. Stock draw would account for 1.9 million b/d of the total. The remaining 600,000 b/d would include demand restraint, fuel switching and increased production. Of the 2.5 million b/d plan, however, only about 1.3 to 1.4 million b/d of the additional supply ever made it to the market. The quick and successful military campaign and the immediate and dramatic decline in prices encouraged some countries not to implement their share of the plan. In the countries where stocks were put into the market, company interest was limited.

Historically (i.e. before Clinton), it took much more than this kind of price pressure to open the Strategic Reserve. So it is unlikely that the opening of the reserve is in response to BP and the current level of conflict in the Middle East. The only ways it makes sense are if we are using the BP issue to take away Iran's best card in anticipation of war, or if we created the issue to take away Iran's best card in anticipation of war.

It's possible that we have issued our intentions to the Iranians, and they called us on it, saying, “Come and git me, Coppah.” If so, we will soon find out because very shortly other signs of mobilization will appear. We would see further rearrangement of assets until we were right on their doorstep, ready to do battle. And it would be methodical. Every step of the mobilization would be taken with two things in mind: public perception, and tactical reality.

Of course, the obverse of this theory is that Iran struck the pipeline as one of the twenty-two pressure points they identified. That would mean they have started to implement their plan. Which would mean certain war. But I don't think that happened.

So even if the conspiracy theory is wrong, which is likely, you think war is inevitable?

No. Not inevitable. Iran will get to make that choice. As we conspicuously ready our power, the question is:

Will she sit, strike, or surrender?