Because the artificial suppression of interest rates worked so well to blow up asset prices, some of which are now in the severe hangover phase, the powers that be are tossing their prized ESG standards in the garbage for pre-election pandering. While holding two separate and competing thoughts at the same time has been noted as a sign of superior intelligence, it needless to say is difficult to apply that aphorism to the elected populace at large. Or small.
From the Ever Thoughtful and Readable Byrne Hobart at The Diff
Central banks like using simple and well-understood tools, because they’re trying to get other financial actors to behave in a certain way and that behavior is more predictable if it’s tied to a known variable. But when they get worried that short-term rates are not strong enough, they’ll sometimes take action by buying longer-duration securities to set the kind of yield curve they want.
A similar situation now applies to oil: per a new announcement, the strategic petroleum reserve is not just buying and then releasing oil, it is “moving forward with a proposal to allow fixed-price forward purchases of crude oil to replenish the SPR and encourage short-term production.” What the SPR can do right now is limit oil price fluctuations driven by immediate supply and demand, but what it could do is give energy companies an incentive to drill now with the expectation that there will be a ready market for their product in the future.
One way to model energy companies is that they’re doing the same kind of CAPM analysis every other investor is doing, and they’re implicitly setting the volatility of oil high enough that they demand a very high return before they produce more instead of buying back stock and paying dividends. The SPR’s historical function is to reduce short-term volatility, but the trouble with any short-term volatility reduction mechanism is that if it has finite firepower, it fattens the tails of the distribution: if the SPR runs out of empty space during a glut or runs out of oil during a shortage, price swings get wilder. By pre-committing, it’s reducing future oil volatility, and raising the risk-adjusted return of drilling for more oil today.
