NVDL: Ja, I'm going to make a bold statement. One of the wealthiest men in the world, and one of the savviest investors has got it wrong with his assessment of the oil bubble. He has also got a bit too close to the financial figures, and is himself a victim of wish fulfillment. Reality and what we want to happen (and hope) aren't the same thing. In fact we are about to pay a heavy price for our misplaced perception that oil - which underpins everything, and to a large extent our daily economic stasis, is now under threat. As such, it is almost impossible to place a dollar value on the stuff. Which means the price of oil is theoretically limitless once one begins to appreciate its real value. In short - Mr Soros, the oil price is not a bubble. It will not pop after $150, or $200 or $250.
A recession in US may allow for some sustained stability, but not for long. Oil will break our financial system, and it will break world civilisation as we know it. And we're right there, right now. Most people have not been willing to face this 'negative and pessimistic' news. Well, if you have cancer you can also choose not to face it. But the cancer still remains. And then we have to wonder how smart the psychology of ignorance in favor of positivity really is.
The example I often give is this. No one places any value on air or water. And when it's abundant it is vital, but worthless. But when it is no longer abundant, it's value increases rapidly. Since oil also underpins our ability to survive (to eat, to move, to warm our homes), it has inestimable value. Furthermore, our large scale addiction to the stuff as an integral part of daily activity means we now face fundamental and revolutionary change on a planet wide scale. Yes, now.
I found this quote: "The situations that men define as true, become true for them." Sociologist William Thomas, 1928 and a fascinating in-depth look at this topic here.
Soros: "So we can observe three very different conditions in history: the “normal,” in which the participants’ views and the actual state of affairs tend to converge; and two far-from- equilibrium conditions, one of apparent changelessness, in which thinking and reality are very far apart and show no tendency to converge, and one of revolutionary change in which the actual situation is so novel and unexpected and changing so rapidly that the participants’ views cannot keep up with it."I can pontificate about my thoughts when I studied economics at university (that people's affinity and knowledge of brands and other associated information would also be an artificial impact on the prices of things beyond their real value.) Essentially I felt that the insider trading laws were absurd, because reflexivity [what I call trading on sentiment, perceptions of conventional financial wisdom] is happening in various shades of gray anyway. Seems like I was onto Soros thinking without knowing it. Difference is, he made money out of it, I didn't.
Nate Hagens:
In financial markets (which include oil futures), reflexivity occurs when prices themselves influence the fundamentals and that this newly-influenced set of fundamentals then changes expectations, thus influencing prices. This process then continues in a self-reinforcing pattern until it has overshot equilibrium. Because the pattern is self-perpetuating, markets tend towards disequilibrium- where every outcome is uniquely different from the past. (This of course flies in the face of most everything I was taught at the University of Chicago Business School)
People like James Kunstler have also spoken for years now about how delusional the markets are, expressed in the stock exchange index figures, where speculators have increasingly put themselves in a win/win situation. That's not how markets work. You can't profit realistically from a change in two opposing industries and still have the aggregate market increase. Not sure if that makes sense. I mean if oil prices go up, property markets ought to drop... stock markets ought to drop, because it makes it more difficult (costly) for markets to operate. But what happens is speculators buy oil and the whole market lifts, then when oil drops, they buy something else, perhaps financials, and the whole market lifts. It doesn't make sense. Oil up = market down, oil down = market up. That's a rational psychology, and it is not nearly reflected in the daily machinations of the market.
Here's an awesome analysis by Nate Hagens from Theoildrum.com:
Imagine that there were no Ken Deffeyes, Matt Simmons or Colin Campbell. Imagine that M. King Hubbert spent his retirement playing Parchesi with his wife and not modeling future oil depletion. Imagine that when the UK hit is second (and final) peak in 1999 that no one noticed, and that market participants didn't pay attention to the subsequent 12 fold increase in oil prices. Imagine we didn't know that the energy return on crude oil had declined from over 100:1, to 30:1 to around 10:1. Imagine that Nigerian rebels and Iraqi freedom fighters couldn't cause daily spikes in crude prices by their actions due to the fragility of supply and demand. Imagine that bandits weren't stealing scarce diesel fuel at night in California. And, imagine if places like theoildrum, or ASPO or energybulletin [or NVDL] didn't continually posit data and questions that pushed the envelope of conventional energy wisdom. Consider then only geology. That we use horizontal drilling and nitrogen and water injection, that we are drilling more and more wells all around the world using the latest seismic technology, etc. That the EIA continues to model supply forecasts with demand forecasts, because supply has never really been a constraint in the past....Would oil prices be approaching $130? Would T Boone Pickens be interviewed with a mixture of awe and fear on CNBC? Would there be major military presence in what was formerly the fertile crescent? Probably not. Yesterdays 'facts' are influencing today's perceptions which are influencing tomorrows realities.
$100+ oil DOES change consumption habits, but it also changes humans built in beliefs towards their futures, both individually and as nations. Earlier this week the CEO of TOTAL, one of the worlds largest oil companies, stated that new forms of energy would not be able to compensate for the coming oil and gas depletion. He also stated that new oil reserves cost $80 to procure so $80 would become the new price floor for oil going forward. We don't know that this is a fact - but is the opinion of an expert in a position to know more than the average participant. Monsieur de Margerie, via his perceived authority and public pronouncements is therby affecting the fundamentals of the oil industry. Each incremental admission, whether from the IEA, from TOTAL, or from theoildrum.com, shifts the mindsets of participants at the margin, which subsequently changes behaviours.
In 1999 with oil below $10 per barrel, the stock market at all time highs, and resource limit concerns restricted to a handful of cranky environmentalists and Hubbert acolytes, were we at 'equilibrium'? In 2001 with oil at $20? In 2005 with oil at $50? The point is that for a very long time we were not in equilibrium - the pendulum was pulled way to the left and finally let fly in 2000 - the question is, has it now past equilibrium in the other direction? Or have we moved into the third stage, where human collective awareness is accelerating knowledge about and action in the oil sector? More knowledge about finite flow limits changes professionals opinions about the future, which changes investment into refineries, changes long term contracts with exporting nations, changes military strategies, changes hoarding strategies, all of which are reflected in the price moonshot. Soros theory, which I happen to subscribe to, implies we will overshoot in both directions, because gravity and momementum will combine to send the pendulum backwards once market participants have not only caught up, but exceeded the reality of the situation. But Soros (to my knowledge) generally applied this principle to finance, and admitted to Congress he is not an expert in things energy. [Amen brother]. Reflexivity could of course have larger societal implications beyond investment booms and busts.
Nearly two years ago, in this post about the Amaranth blow up, I suggested that price floors and position limits would eventually become a reality because of the sheer size of dollars vs notional energy values. In A Closer Look at Futures, I commented:
I believe there are 3 different definitions of Peak Oil and they will come in succession.
- The point when we have used half of the oil that will ever be extracted.
- The point when we reach maximum sustained production (given that we use high technology like horizontal drilling and water and nitrogen injection, we are likely borrowing from the second half of what was normally a bell shaped curve so this point will come later).
- The point when the meme of finite energy resources takes hold in society.
Here is my 'participant' part of the equation of Peak Oil. These are not facts, but my opinions:
1)There will be extreme volatility in next 5 years in oil and gas prices. Not only day to day, but year to year. Awareness of possible flow constraints is now upon us, rightly or wrongly. This combined with the tiny size of energy commodity markets compared to investable dollars will engender large position sizes that inevitably will fall victim to the fear/greed/leverage trifecta. Attention to the oil sector guarantees increased volatility. Accelerating oil depletion of older wells and skyrocketing reserve replacement costs guarantees higher highs and higher lows...
2)The Peak Oil community (e.g. those who generally understand that oil production is either peaking now or will peak soon) will begin to bifurcate into two relatively disparate camps - a)the supply-side camp that understands the urgency but will try and address energy and resource shortage via technology, more drilling and alternatives and b)the demand-side camp [That's NVDL] who will see that no matter what the energy source, a new paradigm of how we live our lives will be the only satisfactory answer to the twin problems of peak fossil fuels and a growing population. Conversations between these two camps will become increasingly disparate and tense. [Personally I believe we need to focus and emphasise the demand side, but obviously a fraction of attention needs to be applied to technologies that might alleviate our situation. Of course, currently, the focus is on supply side to an order of 90% if not more, with far too little focus on our rapacious and pernicious habits.]
3)There will be an eventual slowing and ultimately a cessation of speculation in energy markets by non-producers. This is tantamount to a change in capitalism so I don't say it lightly, but already only 6% of world oil reserves are owned by public companies - the amount of dollars NOW dwarfs the amount of notional physical resources - if printing presses are turned on while resources deplete this disparity will continue to grow. At some point people like you and I won't be allowed to buy oil futures, which is only a short step away from nationalization of the energy industry (which is the case in most countries already).
Conversations and thoughts like these are meant to raise the bar of discourse on energy topics so when real policy discussions take place, either locally or regionally, people will speak a common language. There is a fine line in peak oil outreach - more awareness is needed to accelerate renewable infrastructure and kick-start efficiency and conservation measures - yet too much awareness might cause supply disruptions (hoarding) and make it difficult for oil companies to extend the time horizon that we have access to a large baseline of production, etc.
As an editor on this site, I hope we are efforting positive change, but realize many of our readers are likely tuning in to know the latest details in order to improve their own situation, financial or otherwise. One of my concerns is when the pendulum swings back the other direction, and we head towards one of those 'higher lows', that the urgency of both supply and demand response will be lost. These are high stakes.
[I think the pendulum has a lot of sway left...beyond $200 right now may cause it to swing back to $150 or so. I believe oil prices are still cheap. They don't reflect our dependence.]
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