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In August 2005, over on DU's Peak Oil board, I made a bet with two other members on the price of oil. The bet was whether three years later on August 31, 2008, oil would be above or below $70 per barrel. The bet was for the price of one barrel of oil on that date.
At the time I was a Peak Oil fundamentalist, and thought I had the future of oil pretty well figured out -- rising prices forever, even in the face of the inevitable economic slowdown triggered by stagnant or declining oil supplies. As it turned out, robertpaulson and I won the bet, as oil closed at $115 that day. But the price was already on its way down from the June high of $147, and six weeks later it slipped back below $70 on its way down to $40 -- from which it has recovered back to, yep, around $70.
The outcome of that bet taught me that there's a lot more to oil prices than simple supply and demand. There's speculation of course, and there are the underlying economic drivers (the price of a resource drops when people stop doing things that require it). But above all there seems to be a lot of "human herding behaviour". When people see the price of something go up they assume it's becoming more valuable, rush to buy it, and -- lo and behold -- the price keeps going up. Then the social mood changes, the price begins to fall, and people flee the investment -- causing the price to fall even further, until the social mood changes once again and the price starts to rise once more.
My basic error was in assuming that the oil market, like any other market you care to name, is rational and tends towards equilibrium -- the Efficient Market Hypothesis. In fact, it seems as though prices largely ride on (or reflect) the prevailing social mood, whether they are prices for oil or stocks. Because they reflect human psychology at least as much as their underlying fundamentals, there is no reason to expect stock or commodity prices to reach an equilibrium, or to purely reflect the fundamentals.
This understanding may be what enables some speculators to make a killing an any market. Either consciously or unconsciously they read the "social mood" of the market, get ahead of the price movement and make a killing. Those of us who think the market is an aggregation of rational actors and is driven largely by its fundamentals (even if those fundamentals are somewhat skewed by profiteers) are destined to lose our shirts, because our responses will always lag the prices.
I still think that Peak Oil is a real, geological phenomenon, but I now have a somewhat more nuanced view of how that will play out in the real world, especially with regards to oil prices. One of the factors I had seriously underestimated is the power of social mood and human herding.
Another way of looking at our current predicament with oil is this:
We have an over-extended and structurally brittle global economy, overly complex market mechanisms in virtually every aspect of trade, a lack of national regulations and an inability to regulate international transactions in a world that has been mortgaging its future by running on debt, with the whole Rube Goldberg contraption powered by a resource engine based on exhaustible fossil fuels. As oil supplies become more constrained, what could possibly go wrong?
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