Archive for September 3rd, 2008

Volatility:Deciphering the Price of Oil

Sharon September 3rd, 2008

A couple of years ago, I got to hear both Richard Heinberg and Matthew Simmons warn that one of the biggest concerns we faced in the coming energy decades was not so much consistently rising prices, but oil price volatility.  That is, as prices fluctuate dramatically in response to situational issues, supply constraints and changes in demand, the prices fail to send a consistent message that we can respond to.

As Heinberg writes in his book _The Oil Depletion Protocol_, “….as oil production declines prices will almost certainly rise, although probably in unpredictable increments.  Prices will become more volatile”  It is worth noting that “volatility” doesn’t mean – a perfectly consistent, extended rise in price – it means rapid fluctuations.  And, in fact, that’s what we’re seeing – oil rose dramatically this spring and early summer, and has now declined again.  A number of people are wondering whether our summer spike was an indication of anything at all.  By the time oil dropped back into the low 120s, there was news that SUV sales were going up again.   Now the voices are coming out of the woodwork, saying it was never peak oil after all.

And they have some justification.  A lot of people, not excluding myself, got a little heady with all the sudden attention to peak oil ideas – all of a sudden the mainstream media comes calling and everyone is talking about the price of oil  -and how it might go up further, to $200 barrel, $300…. sometime next week.  It was very tempting (and I personally sometimes succumbed) to convince oneself that the trend was going to continue and that we were now going to see a clear and direct “PEAK OIL IS HERE!!!” neon sign flashing – and to read events as proof peak energy.

But, of course, I knew (and most other commentators knew) that that’s neither how markets work nor how peak oil is likely to go.  In fact, among ourselves, when we’d talk, most of us would say things like “I can’t believe how fast it is happening.”  And often, when you can’t believe how fast something has happened, that’s probably a good sign that it will do something else soon enough.  This is worth remembering.

Now some of the price spike was almost certainly driven by speculation, as we discussed, as among other people, Greenpa kept reminding us - Nate Hagens has a great piece over at The Oil Drum on just that point.  But a lot of it was about market fundamentals – the fundamentals of supply and demand.  Supply is up a little bit, and demand is down – what is different between now and this past spring is pretty simple – most Americans have spent their stimulus checks, they have heard the news about driving vacations and they’ve seen the writing on the wall financially.  Meanwhile, Britain is officially in a recession, the Olympics with their massive energy push are over, and a lot of countries are headed into a recession or depression – and people don’t have money for gas.  Meanwhile food prices remain high, which means that the new middle class in developing nations has less money to spend on gas and other energy powered things.  We paid a lot of our money out to energy producing countries, and now we don’t have it any more to buy with.

And just as Heinberg and others have pointed out – we’re more endangered by price volatility than by consistent prices rises.  The next time oil prices jump near $150, how many nay sayers will there be, pointing out that they came down before, right?  Instead of spending their money reinsulating, people will say “Well, I guess I can handle these high energy prices one more year, right?  Next year they could be cheaper.”

Which ignores the fact that lower energy prices aren’t actually a good thing.  Everything I wrote here is still pretty much true and getting worse.  The power crisis in 100 nations is more acute than ever.  Energy prices are still squeezing farmers, and the farmers who couldn’t afford to plant at all in poor countries still have empty fields and hunger to worry about.   The winter heating crisis may be 22% less acute in terms of price, but in terms of people who are losing jobs and no longer can put things on their credit cards, it may actually be worse.  Deflation isn’t really a lot of fun.

But what happens when we get too excited by any short term trend is both a loss of credibility by those who see things only in the simplest possible terms, and also, a loss of the right message – the story doesn’t get through, and we all pay a price.  Volatility is one of the clearest signs that we’re near the peak – and one of the most dangerous ones across the board, even for those, like me, who should know better.