E.D.Hart

Confirmatory Bias and Oil Investing

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.

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?

Crude Oil Seeks Iranian Black Swan

Black swan events are highly improbable events, but it is not impossible to take them into account--it is just against human nature to consider them. In other words, you can take into consideration in your investment process the need to expect the unexpected--though you may not know the cause.



Hurricanes, war, nuclear strike, terrorist hit on major shipping lane or pipeline...who knows where the next spike is going to come from?


The fact is, global oil supply constrints are near critical levels, and spare capacity is very tight, much less than weve been told by the Suadis.

Dollar depreciation explains about 20% of the oil price rise, but the other 80% is related to a new scarcity psychology taking root: end users are getting nervous that they wont be able to get crude when they need it. This is primarily due to very limited spare capacity.

The oil market is ripe for a spike above todays levels...but then again, no one knows.

I can't predict the specific cause...but I agree with Sophisse above that there is a corresponding asymmetrical positive black swan that might mitigate global oil constraints to spare capacity...however the time delay of oil to market makes this less impactful.

Demenad destruction is occurring in the US with higher prices, yet in no way is this a way to lower prices over the mid to long term. The reason is that gasoline doesn't trade in a free market, if one takes into account the numerous markets around the world with gasoline subsidies.

Chinese subsidies resulted in gas shortages in China because the refineries were not willing to supply all the gas the market needed at a loss to their bottom line. (even after government paybacks).

The counterintuitive result is that as subsidies in China and other countries are gradually rolled back, gasoline consumption will likely increase, not decrease.

Summary: Higher prices in subsidized markets= higher consumption due to much wider availability of the product. This is not included in most economic models.

Moreover, the revaluation of currencies around the world that are linked to the dollar will result in much higher buying power, and will mitigate against the higher prices of fuel. Some authors say that the yuan is primed to appreciate 1 to 2 times against the dollar.

The Chinese and others will see much slower rises in fuel costs if and when they revalue their currencies. Demand destruction in emerging economies is apt to be a very minor occurrence in the medium to long term. We may see some over the near term.

In summary, higher oil prices are hear to stay. Much of the cause is from the new appreciation of severely limited spare capacity which introduces a fear factor that was heretofore not present in the main.

The second, lesser cause, is dollar depreciation and corresponding yuan (and other currencies) appreciation coupled with emerging economic growth.

Finally, as there is not a free market in gasoline in much of the world, atypical consequences result from higher prices in subsidized gas markets, resulting in greater gasoline use, and greater demand for crude.

P.S.--Huge intelligence failures are well documented, and widely known. Both parties, and many military, and intelligence leaders have written well documented books on the Iraq intelligence fiasco. There has not been a greater intelligence failure in my lifetime, and several generals have said this.