Goodhart’s Law and OPEC’s output deal

No evidence has emerged of cheating on the OPEC/non-OPEC production agreement so far. But Goodhart’s Law is a reminder traders should expect countries to try to circumvent any target once it has been chosen.

Goodhart’s Law states that any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.

Charles Goodhart was a Bank of England official and he was expressing the bank’s frustration that any measure of the money supply it started targeting ceased to be a good target soon after it was chosen.

Anthropologist Marilyn Strathern subsequently reformulated the law as a more general problem of measurement and accountability in any organisation or system.

“When a measure becomes a target, it ceases to be a good measure,” she wrote Central bankers have long known that once a target is chosen, banks and other institutions have a strong incentive to innovate around it to escape from control.

The question is whether OPEC and non-OPEC countries will fall victim to the same problem with their agreement to reduce oil output now they have settled on a measure to assess compliance.

The Organization of the Petroleum Exporting Countries publishes two figures for its members’ oil production in its “Monthly Oil Market Report”.

The first is based on direct communications from member countries while the second is based on a survey of six secondary sources, mostly statistical agencies and specialist oil industry publishers.

The secondary sources are Platts and Argus,? the US Energy Information Administration, the International Energy Agency, Cambridge Energy Research Associates, and Petroleum Intelligence Weekly.

The use of secondary sources dates from disputes in the 1980s about whether members were submitting inaccurate data to cheat on their output allocations (Goodhart’s Law in operation again).

So the OPEC agreement reached towards the end of 2016 relies on secondary sources rather than direct communications to set both the production level and assess compliance with the target.

The use of secondary sources was a key demand from Saudi Arabia to ensure the agreement was transparent, credible and verifiable.

But the selection of the secondary sources as the control target has put the system under scrutiny and pressure as never before.

Before the agreement was reached, Iraq in particular devoted a lot of effort to lobbying the secondary sources to raise their estimates of its output and bring them into line with government figures.

The apparent aim was to establish a higher production baseline from which any subsequent cuts would be calculated.

Iraq started to share detailed field-byfield production data with the secondary sources and other media organisations in an effort to bring their estimates closer to government numbers.

Now the agreement is in operation, the question is how accurately the secondary sources are capturing OPEC members’ production.

Secondary source estimates have become the focus of intense interest as OPEC officials have sought to focus oil traders’ attention on compliance.

In general, the secondary sources show aggregate compliance has been high, with Saudi Arabia shouldering more than its fair share to make up from weaker compliance by other members.

But in an ironic twist, confusion has arisen about the Saudi numbers, where have been unusually large discrepancies between government production data and secondary source estimates for January and February.

Secondary sources and government production data (notified to OPEC and the Joint Organisations Data Initiative) usually track each other closely in the case of Saudi Arabia.

Secondary source estimates are normally a little lower than government production data, but the gap averaged just 72,000 bpd in 2016 and was never greater than 102,000 bpd.

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