Oil Market Driven by Fear
This summer, when global oil prices surged to an apocalyptic US$150 a barrel and filling up the gas tank began to feel like making a mortgage payment, radio call-in shows were in an uproar. My voice mail fielded almost-daily invitations to answer questions on "the oil crisis" for one station or another. That invariably meant coming ear-to-face with the public's visceral fury. In three months, the oil price had shot up by 50 per cent and had more than doubled in less than a year. Anybody with a car and a furnace was ready to lash out - at "greedy speculators," at Alberta, at billionaire oil barons, even at innocent journalists cheerfully answering their questions out of the goodness of their heart.
How, they asked, could prices change so fast? And why? Why!? Why dammit!!
Nerves aren't nearly so raw now that extreme volatility is working in the opposite direction. Oil is now in sudden free fall, having dipped below US$50 a barrel last week for the first time in years. Crude has plunged by roughly two-thirds in four months, but the open-line shows are conspicuously quiet. The fact that oil went from US$85 to US$150 to US$50 in 12 months tells us something important, not only about the shape of the global economy, but also about the forces that dictate our oil and gas bills. But you won't hear it discussed much on talk radio.
There is a fundamental misunderstanding about ENERGY prices, which is exacerbated by analysts and executives who continually insist that prices are driven by supply and demand. This is misleading, and the constant repetition of this idea has produced in people a widespread distrust of the energy industry. These days, the price of oil is driven primarily by expectations of future supply and demand months and even years down the line. We have a pretty decent idea of what current supply and demand are, and how big global stockpiles are. But trying to estimate the future is little more than educated guesswork, subject to the naturally distorting effects of human emotion.
That guesswork is further complicated by the fact that global oil supply is routinely manipulated. The Organization of the Petroleum Exporting Countries (better known as OPEC, and dominated by our dear friends in Saudi Arabia and Iran) open and close the spigot arbitrarily, to maximize their own profits, often at the expense of market stability. OPEC members routinely lie to each other about how much oil they're pumping on a monthly basis. It may be technically true that supply and demand drive the price - except that demand is estimated, and supply is manipulated. So is it any wonder that nobody has any firm idea of what a barrel really ought to cost at any given moment?
It's often said that all markets are driven by the constant war between fear and greed, but the oil market is an exception. It is only ever driven by different forms of fear. Last summer, when oil hit US$150, the fear was of global shortages. With China and India expanding at a blistering pace, and much of the world supply buried beneath an ancient war zone, traders swapped stories of pipeline bombings and millions of Chinese urbanites preparing to buy their first car. Now, with oil at US$50, the overriding fear is of a sudden collapse in global trade. The question is no longer whether the world economy is growing too fast, but whether it will grow at all over the next couple of years. Pick your poison: the bulls are all about unstable supply; the bears are obsessed with anemic demand. Right now, the bears are on top, but that'll change. It always does.
It's enough to drive a poor commuter nuts, and sometimes it seems like it has. No other commodity is such a constant and looming presence in our lives, and so nothing else has the same power to get our blood boiling. The price for copper soared for more than a year (also driven by burgeoning demand in Asia) and has recently collapsed. But unless you're a copper miner or happen to be replacing your plumbing, nobody much cares.
This is understandable, but not entirely rational. If we really sat back and thought about it, we'd be far more worried about the impact that falling energy prices have had on the Canadian stock market and the value of the loonie in recent months. Stocks are in the midst of a crash every bit as bad as the one in 1987, and far worse than in 2000. But where most crashes work like explosions, this one is unfolding more like an earthquake with multiple aftershocks, and the victims are piling up. If you've been diligently socking away money into mutual funds for the past few decades, chances are your losses are now well into six figures. By contrast, when gas jumps from 85 cents to $1.25 a litre, it costs an extra $20 to fill up a 50-litre tank. If you drive a lot, and fill up about twice a week, that surge adds about $2,000 to your annual gasoline bill - not chump change by any means, but miniscule compared to the impact of the recent market meltdown. A new survey from Desjardins Financial just revealed that almost half of Canadians over the age of 40 now expect they will have to delay their retirement plans by an average of almost six years due to the market turmoil. That kind of news produces weary resignation. Meanwhile, a 10-cent jump at the gas pump has people ready to man the barricades.
The psychology of all this is simple enough. Retirement is a distant and intangible concept for most Canadians. Statements of RRSP savings arrive in the mail every three months. Gasoline prices are posted on the street corners and are a constant daily reminder of our financial stresses, and the forces beyond our control. Perhaps our priorities would be different if the value of our retirement savings were tracked hourly and posted in bright lights at every major intersection.
If we can't be entirely rational about oil prices, it should at least be possible to keep them in perspective. A cheaper tank of gas is a welcome bonus in tough times. Enjoy it for what it's worth, and while it lasts. But falling oil prices are nothing to celebrate.
Maclean's December 8, 2008