Confirmatory Bias and Oil Investing 41 comments
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I recently came across a post on the Victor Niederhoffer Blog about the concept of Confirmatory Bias. I shall reprint the standard quote from Sir Francis Bacon that is used in much of the literature on this subject:
The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate...
After searching further, I came across a paper published in the Review of General Psychology in 1998 authored by Raymond S. Nickerson of Tufts University. I believe that the concepts he discusses have applicability to current beliefs by bullish energy investors about Oil.
Nickerson presents a modern definition of the concept of Confirmatory Bias:
...the seeking or interpreting of evidence in ways that are partial to existing beliefs, expectations, or a hypothesis in hand.
In his paper he reduces the concept to its component parts. I will discuss four of them, and then present my own.
Number 1 - Restriction of attention to a favored hypothesis.
"If one entertains only a single possible explanation of some event or phenomenon, one precludes the possibility of interpreting data as supportive of any alternative explanation."
Oil bulls believe that the only thing that can explain high oil prices is the trite hypothesis currently circulating in the market - that strong demand from emerging economies and limited, or even peak supply, is responsible. All other evidence to the contrary is ignored. The possibility that "speculators" or "traders" or "momentum players" may be partly responsible for a premium is scorned.
This belief, of course, ignores 220 years of history in the American financial markets, where there have been many cases of market speculation and/or manipulation, from Erie Canal bonds to Railroad bonds to Internet stocks. The real question that one should ask is the inverse of this - is there any financial instrument and/or Commodity that hasn't been subject to speculation or manipulation or overvaluation?
Number 2 - Preferential treatment of evidence supporting existing beliefs.
"...the tendency to give greater weight to information that is supportive of existing beliefs or opinions than to information that runs counter to them. This does not necessarily mean completely ignoring the counter indicative information but means being less receptive to it..."
This is seen regularly in any statistical report issued regarding oil. If the Department of Energy (DOE) or the International Agency Energy (IEA) comes out with any report that challenges the bull - the report is "bad data." Any statistics that support the bull is trumpeted for the world to see, thus proving the investment case.
If economic activity in the U.S. and other OECD nations slows down, leading to less demand for oil, it doesn't matter, as long as demand in China continues to grow at its absolute number of 500 thousand barrels a day. The fact that a 2% contraction in oil demand by the OECD would be twice China's absolute growth is not given any weight by the market.
Number 3 - Overweighting positive confirmatory instances.
"Studies of social judgment provide evidence that people tend to overweight positive confirmatory evidence or underweight negative discomfirmatory evidence."
The International Agency Energy (IEA) last week revised its estimates for the supply and demand situation in oil. The part of the report that made the headline was its prediction that the oil market would remain "tight" for the next five years. What was ignored was the negative information that the IEA had cut demand growth from 2.2 to 1.6% per year on average for the next five years. Although this cut in demand came from the mature economies and not the emerging economies, it is the equivalent of 500 thousand barrel a day of demand being taken off the market. This equals all of the growth in China every year for the next five years.
Number 4 - Seeing what one is looking for.
"People sometimes see in data the patterns for which they are looking, regardless of whether the patterns are really there."
This is also very prevalent in oil markets. Every other week there is news about some labor strife in Nigeria, a major oil exporter. This usually results in a couple hundred thousand barrels a day being temporarily removed from the market, and a $4 dollar a barrel rise in price. Yet when Saudi Arabia increases production by 500 thousand barrels a day, the market doesn't care. Investors see a temporary supply disruption as permanent, and ignore a permanent increase.
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This article has 41 comments:
My only observation is that bias are learned from experience and more often than not are well founded. Why would one suspect himself of error when his personal history tells him that, on the whole, his judgment has been reliable? Did you know that Bacon was a thief and was convicted for thief? His character was hardly better than his over generalizations, of was that his point?
I must say that the "peak oil" enthusiasts do have a one-track mind. Whether they are not intelligent enough to weigh more than one variable (cause) at a time, or whether their beliefs are simply too strong to allow a complex mental representation of the reality, they seem to be mired in simplisme.
For me, the cost of oil or why it is expensive is secondary to transcending oil and our reliance on a single type of fuel. We need to diversify.
However, the phenomenon of confirmatory bias that you point out is of course most rampant and interesting. We generally see what we want to see...
The article author's bias becomes apparent with this statement:
"Investors ...ignore a permanent increase."
A "permanent" increase? That would seem to be an admission of belief in the abiotic origin of oil; i.e. the notion that oil is not a finite, non-renewable resource but is in fact infinite. This is even more of a fringe belief - by far - then peak oil!
The essay appears to be a work in over-generalization. This is just as fallacious a logical approach as confirmation bias, of course. Rather ironic.
A final comment: this statement: "Every other week there is news about some labor strife in Nigeria" certainly appears to qualify as confirmation bias in its own right under one of the definitions the author himself provides: "...the tendency to give greater weight to information that is supportive of existing beliefs or opinions than to information that runs counter to them. This does not necessarily mean completely ignoring the counter indicative information but means being less receptive to it..."
Bombs blowing up oil pipelines = labor strife?
Doubly ironic.
How is that? Please note, none of the factors mentioned are directly related to oil but they are predictable like a Swiss watch. Investment in oil is a protection against self-inflicted inflation. Well, that is trivial. Not difficult to be a bull even on a choppy day like this.
Due to OPEC, downside risk for the oil bulls is rather limited, while upside is not so.
PREDICTION:
If oil approaches $105-110 (which I think is quite unlikely), watch Saudi Arabia rescind its recently-announced 200K bpd of extra production that began this month. And if oil goes below $100 (which I consider extremely unlikely), watch Saudi Arabia reverse the full 500K production increase between May's and July's increases.
Jack Yetiv
If you are long on oil -- your greed is turning to fear.
Greed and fear -- at its most basic 'the market' is controlled by these two emotions.
There is no "peak" of oil in the foreseeable future.
Oil is a mineral, not the remnant of 'organic detritus'.
The scientific basis is clear.
And, yes, geologists have been caught up in the above psychology for decades. check out <a
Href="oilismastery.blogspot..../ "> Oil Is Mastery. And learn the truth about oil.
When Yahoo was up 1000% it seemed to be a bubble. It rose another 15 fold. After Alan Greenspan made his famous comment on irrational exhuberance.
From 1990 to 2000 Dell went up over 100,000%. Oil is different, but you just cannot rely on Francis Bacon to call this a top.
His only job was to predict oil prices.
His confirmation bias was obvious in retrospect, but not at the time.
Peak oil is a theory that has proven true in the US, as well as lesser oil producing countries-- a plateau was reached, and then decline.
People now are applying the theory to the world as a whole, which is not outlandish.
The most emotional arguments that I hear are not from the peak oil theorists, but from everyday folks, and everyday news channels that oil is cheap and abundant, but oil companies are reaping obscene profits, and greedy manipulators are stealing Americas wealth.
Guess which side appears to have the higher level of confirmation bias?
I completely agree with your thought that all investors need to be concerned with confirmation bias, and I highly recommend The Black Swan for that concept and others. However it is a risk and pitfall that every investor needs to struggle against (with the possible exception of index investors).
I agree with you about the peak oil crowd, but the same applies to the oil bubble crowd.
During last week or two, whenever somebody wrote something negative about crude oil price, hordes of retails would come out bashing the author with expletives.
That was the signal for me to get rid off my USO at 114.
starkoski: You are right, geology beats psychology -- but geology is wrong about the origin of oil. Oil is a mineral. Why do you think the oilfield services companies are riding high? If there wasn't much more oil out there to find, it wouldn't matter how high was the price of oil. Oilfield services companies are in the business to find oil.
The U.S. plateau in the '70s was when oil was regulated, some as low as $3 a barrel -- big surprise oil companies weren't looking for oil.
The continental margin is where the truly big deposits of oil are and that has just begun to be explored.
That's why day rates for deepwater, deep-drilling rigs are at record highs.
'Markets' are determined, not so much by the logic of words as by the sterner logic of facts.
Demand destruction is real -- "Peak" oil is false.
"Peak" oil is rubbish -- <a
Href=“http://oilismast... “> Oil Is Mastery.
If you want to look at the science of oil then Oil Is Mastery is the place -- your blind devotion to "Peak" oil will make you a poor fellow.
Your arogance will be your downfall.
> jack
akapital9....you said "now is the time to invest in non-fossil fuels such as solar, bio-fuels, and wind."
ozzy43....you said "oil bulls are bullish for different reasons."
It seems the main arguments are always the same - strong demand from emerging economies and limited or no supply growth. Everything else flows from that. That wasn't the point of the article, but click on my seeking Alpha and read my other articles on oil.
Also, when I wrote "permanent increase" I meant permanent until the Saudis cut back. I wasn't implying a belief in abiotic oil. As for the labor strife comment - violence can go hand in hand with labor organization and attempts to get more, just look at the history of the American labor movement. Maybe you are right and I oversimplified the issues by labeling them as labor strife. Again, that wasn't the point. The point was that the market used that component of confirmatory bias to weight the loss of Nigerian and the gain in Saudi crude differently.
ehart500...you said "I spoke with the oil economist of the Alaska state government back in 2004 and he said oil wouldn't hold above $50, and he gave me a list of reasons why--including demand destruction."
you are right, people have been screaming about the collapse of oil for many years, but if you look at the data, the high price is finally taking a toll on demand particularly at a time when the economy is weakening and house prices are declining.
crapneck...keep an open mind now - sarcasm is no substitute for analysis. No investment thesis lasts forever. Remember growth always disappoints in the end as every industry is cyclical no matter how growthy it looks and how long the cycle is.
I meant to add that I agree with you on this.
> jack
The conclusion is straightforward enough: diamondoids, like diamonds, are created in the mantle in conjunction with oil.
John S. Gordon, you idea isn't confirmed by science -- the crust is an environment of methane creation and hydrocarbon destruction.
Certainly not diamond creation.
Try getting your science right and you might have an once of credibility.
Oil is an ultramafic mineral (formed in ultra-high heat and pressure) and obeys the rules of all mineral formation dictated by heat and pressure gradient. By the way, this also dictates oil's formation & dissolution.
Oil is a mineral -- unique in certain respects, but still a mineral.
> jack
Good ploy -- change the subject -- don't respond to my point about diamondoids and your obvious mistaken diamond comment.
But going to your new point: "oil is not found in igneous formations (otherwise all of the canadian precambrian shield would be full of oil).
Wrong, again. There is oil found in igneous formations, i.e., the White Tiger oil field off Vietnam's coast and many other examples.
And, yes, there is oil found in precambrian formations. And as far as the Canadian shield -- where do you think all that tar sand came from. Tar sand is generally a high atomic weight, long chain hydrocarbon that never was buried deep enough, according to "fossil" theory to create kerogen. "Diagenesis" is a made-up word for a made up "process" that has no scientific basis or experimental backup.
John says: "oil is found in sedimentary formations where there is a caprock to stop upward migration (otherwise you have a labrea or trinidad type tar pit)."
Correct. But the 'source' is not remnant of organic detritus.
The Saudi oil field Ghawar is the largest oil field in the world. The Ghawar complex is performing extremely well. The field has been on production since the 1950s and is steady at roughly 5 million bopd.
A 19 mile cube of oil has been produced at Ghawar. Roughly 100,000 feet high -- organic detritus supplied that?
But getting back to my point -- what about diamondoids in all oil?
And, again, no diamonds aren't formed in the crust.
ghawar - 19 mile cube. not very impressive compared to all the coal seams in the u.s.a. how much subsidence has occurred there as a result of production? there has been a lot of subsidence in the los angeles basin due to oil removal, i've heard numbers like 15 feet in places.
> jack
'bitumen' is the term the albertans use. not the same thing as kerogen in colorado oil shale (freshwater algal remains).
in 1939 there was oil production on the mackenzie river, NWT @ canol. that was before leduc came in big time.
> jack
The tar sands? You're the one that needs organic detritus to "cook" in the crust, but there's no evidence to support the idea that the tar sand was ever deep enough to "cook." Abiotic theory doesn't require made-up words to describe make believe "processes." Rather, millions of years ago there was a massive 'outpouring' of hydrocarbons to the surface and it has been degrading ever since.
Sulphur is many times mixed in with crude oil, as in 'sour' crude oil. Sulphur is a 'solfataric' mineral that emanates from vents -- sorry, there aren't any large organic detritus sources of sulphur.
Lignite is brown coal that derives from peat bogs -- the one organic source of "coal." Its composition is materially different from anthracite coal or hard coal.
Guess, you gave up on your previous point -- yes, there is plenty of oil in igneous rocks.
The Lost Soldier Field in Wyoming has oil pools at every horizon of the geological section, from the Cambrian sandstone overlying the basement to the upper Cretaceous deposits. A flow of oil was also obtained from the basement itself. Hydrocarbon gases are not rare in igneous and metamorphic rocks of the Canadian Shield.
Potash and dolomite are examples of how wrong geology is at times. Dolomite is an ultramafic (formed in ultra-high heat and pressure) and is found in association with oil in 80% of the oil discoveries in North America, There is the Dolomites mountain chain in Italy (comprised of dolomite), yet geology has no answer because they think it's strictly a sedimentary mineral.
Potash is another mineral that geology holds as sedimentary, but evidence suggests it isn't. It's a mineral that is made of potassium carbon and oxygen -- K2CO3, there are variations -- such is the case with most minerals.
Sorry to disappoint you but coal seams are also abiotic -- 800 foot coal seam in Australia -- sorry, that isn't from organic detritus
Subsidence doesn't disprove or prove either theory.
Your response to Ghawar doesn't explain how all that organic detritus collected at one spot.
Also, 70% of the giant oil fields are located over tectonic faults.
Jack, you're breaking down "geologists say" isn't proof of anything.
Actually, Colorado "oil shale" are the sedimentary remains of lakes where heavy oil, high atomic weight oil, C215H330 leached into the lakes from oil seeps in the raparian watershed. Just like the hundreds of heavy oil seeps in California and in Iraq where oil bubbles from the ground like in the Beverly Hill Billies.
C215H330 atomic weight hydrocarbons doesn't come from marine algae.
Bitumen is also heavy atomic weight long chain hydrocarbons where the volatiles have evaporated oil to leave the solids behind.
Bitumens have been found in igneous rock in Syria with no evidence of sedimentary rocks in the area.
Gotta follow up on those tar sands, since you make so much of them. The enormous quantities of hydrocarbons in the Athabasca tar sands in Canada would have required vast amounts of source rocks for their generation in the conventional discussion, when in fact no source rocks have been found.
Oil is an ultramafic mineral.
To believe the law of supply and demand has been suspended is "IDIOCY."
Demand has gone down in the U.S., that's the facts, Jack, including diesel.
China and India and the rest are also subject to the law of supply and demand -- their prices for gasoline and diesel are going up, too.
China and to some extent India subsidize their oil consumption, which does diminish the demand destruction, but I read prices are increasing in China, too.
The continental margin is where the largest oil deposits are located (excepting the Middle East, which is a continental margin, but above sea level) -- this has just begun to be explored.
Your attempted insults fail to prove your point.
Because it is YOU that have ignored too many facts.
But I invite you to check out Oil Is Mastery to get the facts.
<a
href="oilismatery.blogspot.c.../ ">Oil Is Mastery.
href="oilismastery.blogspot.... /"> Oil is Mastery.