The ghost that haunts the global oil markets

Markets are a sum total of the actions of all participants at any given point in time. Which is why they reflect the quirks, fears, greed and mysterious behaviour of the participants. Each asset class—currencies, bonds, commodities and equities (mentioned in the descending order of daily turnover) trades with its own characteristics.

Where equity markets are like a frisky puppy out for a walk on a leash, prancing around from extreme left to extreme right (volatility in market parlance), currency and bond markets hum quietly within a narrow range of 4 decimal points. Naturally, the skill sets required to navigate these markets cannot be a one-size-fits-all template.

There are set parameters to analyse these asset classes. You can analyse balance sheets, profit and loss accounts of companies and even nations to judge where the asset prices or currency pegs are headed. This rule-based organised approach means trading these markets is a scientific exercise. Of course, human sentiment is also involved, so prices tend to be irrationally volatile at times, but they revert to the mean.

The commodity markets are a different ball game altogether. Can you study the balance sheet of lead or zinc? Then there are the elements. What if a hurricane floods a copper mine? How high can prices go? The primary difference between equities and commodities is the demand-supply equation. In equities, supply (paid up capital of a company) is static whereas demand is elastic. Commodities are a natural resource. If the demand spikes, miners dig deeper into the earth and extract more oil, gas and metals.

Equity trading is like playing football. The goalpost is static. On the other hand, since both demand and supply are elastic, trading commodities is like a sniper firing at a moving target. Any shooter will readily admit that it is infinitely more difficult to gun down a moving target.

Of all the asset classes that you will ever trade, crude oil (and natural gas) will tax you the most. These markets require skills that are not taught in textbooks. You might learn them after losing millions of rupees in thousands of trades, travelling extensively, and networking with senior fellow-traders, hoping to learn a trick or two from them.

Trading equities, forex and bonds requires skills in open source intelligence (OS-Int)—analysing data that is available in the open or public domain. Securities laws in almost all countries require listed companies to reveal financial data to the public on their own websites.

Trading oil demands more attention from participants. In addition to OS-Int, a trader, analyst or journalist must possess the skills to collect, analyse and assess the impact of human intelligence (Hum-Int). It is something I call “boots on the ground and eyes in the skies” approach.

An infantryman firing a rocket launcher at a building from a shoulder-mounted weapon has a different view of the target than a pilot bombing the target from the air. The boots on the ground and eyes in the sky approach offers the best of both the worlds.

Why this approach?

The nature of markets is determined by the collective actions of its participants. Oil traders are secretive, profit-oriented and trust no one. Perhaps the business itself demands don’t-trust-anybody approach since everybody resorts to it as the standard operating procedure. That is what makes OS-Int analysis so inaccurate and inadequate.

Almost half (officially at least) of the global supply of oil is met by the Organisation of Petroleum Exporting Countries. As an oil cartel, OPEC tries to maintain order by imposing export quotas on member-nations. That is a sore point for many members. Almost all OPEC nations are Arabic and therefore experience the Shia/Sunni divide. Members invariably accuse the OPEC head (Saudi Arabia) of dominating the landscape.

The second reason OPEC fails to curtail excessive exports is the method of calculating quotas. Quotas are dynamic and undergo frequent revisions, based on claimed oil discoveries and/or reserves. There is a big difference between claimed and proven reserves. OPEC nations invariably disallow seismic energy audits by western inspectors. They choose to release oil reserves data based on their own findings. The credibility of this data is always suspect.

This means the quota allocation systems is farcical, at best. OPEC members claim to have discovered far more oil than they actually do to get higher quotas. The governing council knows members exaggerate their figures and waters down the quotas. Which means no one trusts anyone at face value. Yet, there is very little disgruntlement at these meetings. If that comes as a surprise to you, wait, there is more. And this is the sinister, slippery, secretive yet critical part of the international oil trade.

Enter ghost markets

What do rebellious children do sometimes when they are restricted from going for a movie? They sneak out and watch it anyway. Which is exactly what disgruntled OPEC member countries do when they are denied export quota hikes. They sell oil in the “ghost markets.”

Ghost markets are parallel markets where off-the-books oil (called ghost inventory) is transported by tanker ships without satellite transponders, country markings or flags. These ships are operated by crew members who invariably don’t carry passports or documents proving their nationality.

Many such ships have been sold and scrapped, as per the record books, but actually still ply in international waters. Most are floating “rust buckets” that are unsafe by maritime standards.

If you’re wondering about territorial laws being broken, these ghost fleets have you covered. Most deliveries are made in the dead of the night when visibility is poor even from overhead satellites.

These ghost ships invariably knock on your international border beyond 12 nautical miles (22.22 km). The ghost cargo is transferred to the buyer’s crude oil carrier ships. Since the GPS transponders are switched off, no one is any wiser.

Shopping for ghost tankers

The majority of the ghost ships originate in Greece, which is the hub of global maritime trade as far as cargo ships are concerned. Many times, old retired “rust buckets” that were used to transport olive (edible) oil are crudely modified to carry black gold (crude oil).

A few structural changes are made on the deck to evade easy identification. All country markers, identification numbers and flags are taken off. Other “suppliers” of ghost fleets are nations that have aging ships being de-commissioned.

For a real world oil trader on financial exchanges, having boots on the ground and/or a network of friends that does is critical for trading success. I have maintained in my weekly Mint columns that I debunk the super cycle theory in oil and gas. Part of the reason is I have seen the sale of “ghost ships” grow exponentially in the past 10 years. Most of the spike came after the Covid lockdowns in 2020. The Ukraine war escalated the process.

Russia alone is estimated to own up to 600 ghost ships. And whispers among veteran oil traders seem to suggest at least one-third (if not higher!) of all Russian oil sales are of ghost inventories ferried by ghost tankers.

So, while my analyst friends were throwing around fancy price targets of as much as $350 a barrel for crude oil after the Russian invasion of Ukraine, I was vociferously advocating a fall in oil prices! My reason was simple – boots on the ground and eyes in the skies. Activity in the ghost inventory market simply exploded. I had seen it in 2012.

Wars are expensive adventures and stakeholders need an almost unlimited supply of money to keep them going. Russia demonstrated that by stepping up ghost trade to finance the Ukrainian war.

Activity only spiked after the 7 October 2023 war in Gaza broke out. If you were to listen to armchair and fireside experts, oil prices should have gone to the moon. If you talked to a real-world trader, he would be shorting these markets.

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It’s one world!

I saw a 2007 Hollywood film “Shooter” that stuck on in my thoughts. The dialogue of the antagonist played by Ned Beatty is something I make all my oil trading friends hear on YouTube: “There are no Shias and Sunnis, Christians and Moslems, righteous or villains. There are no permanent friends or enemies. There are just the haves and the have nots. Now you gotta decide whether you’re in the inside or outside!”

Remember the ISIS in 2012 and 2013? The group uploaded videos of live beheadings of captured soldiers who were defending oil fields in Mosul, Iraq. Every time ISIS uploaded such a video, oil prices spiked a few dollars. That was the natural reaction of the oil markets which feared that if ISIS captured the oil wells in Mosul, they would set them afire and create a global shortage.

Something strange happened

Oil prices crashed after ISIS gained control of these oil wells. Why?

They needed money to finance their war and they had all the free oil from these wells. They sold oil at deeply discounted rates to anyone who wanted to buy oil cheap.

What about transporting this oil from Mosul? It was “facilitated” by a powerful politician of a neighbouring country (no names) who sent over 2,500 large tanker trucks to ferry this oil.

If you’re wondering how this huge armada of trucks made its way across the desert unspotted, remember what Beatty said. Every Tom, Dick, Harry and his aunt Henrietta bought cheap oil from the ISIS.

Whispers suggested a price band of $20-28/barrel. Remember it was stolen oil. To the seller it was still 100% profit! This was a ghost fleet of a different kind. It moved over land instead of floating in the high seas.

The point I am making is Napoleon was not the only ruler who condoned moral latitude when it suited him. He preferred to take generals on crusades, who fought bravely but looted the conquered land for personal gains.

His logic was that even after a few small “leakages” if France still gained a lion’s share of the spoils, it was worth it. It’s a classic example of “vested interest is the best interest.” It works like a charm in the financial markets.

Traders term the oil and gas markets as “widow makers” for their unpredictable price moves. Are they really unpredictable or are traders, analysts and journalists looking at the wrong data?

The classic cause-and-effect theory tells us nothing happens in the financial markets without a reason. And the reason is invariably financial. If you crack the code of the parallel energy markets, you will see the jigsaw pieces fall into place immediately.

Globally, hedge funds compensate oil traders and fund managers not just for their understanding of the business but more importantly, for their network of real world traders savvy about parallel markets. In the energy markets, Hum-Int gathering skills far outweigh OS-Int.

Which is why veteran oil traders will tell you that oil and gas trading is not a pure science. It’s a marriage of science and art. Successful energy traders are brilliant artists. Period.

Vijay L Bhambwani is the author of the first official commodities trading guide in India. He designs statistical and behavioural trading models for his family owned prop trading outfit. He stays at South Mumbai and trades markets since 1986. He tweets at @vijaybhambwani and has a video blog at www.youtube.com/vijaybhambwani

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