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.

 Sharon

10 Responses to “Volatility:Deciphering the Price of Oil”

  1. Brian M.on 03 Sep 2008 at 10:19 am

    Speculators are part of the story as is the supply and demand
    of oil, but the other important factor is the underlying currency.
    A lot of the oil price build up was weakness in the dollar, and
    some of the fall in oil prices in the last month or so has been
    strengthening in the dollar. It isn’t just oil prices that are volatile

  2. Verdeon 03 Sep 2008 at 10:44 am

    Thank you, Thank you. As a reader of things Peak Oil, I knew this…somewhere in my brain but my current thoughts were along the lines of “huh?”.

    I think that the strengthing of the dollar is another thing that’s going for a roller coaster ride - just the way the stock market has been.

  3. Traverse Davieson 03 Sep 2008 at 10:53 am

    The thing is, prices will never go to the level they were at five years ago… and the next time they peak, they will probably settle a little higher than the base price right now, and they will probably peak often… settling a small amount higher each time.

    That’s the way things go, piece by piece, not huge amounts at once.

  4. Meadowlarkon 03 Sep 2008 at 10:58 am

    “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”

    This was my issue with the Pickens Plan. People will use it as an excuse to continue doing exactly as they are doing now and not make any changes.

    We need to make changes NOW. And even then, it could very well be too late to make much of a difference. But if we don’t make any changes, it DEFINITELY will be too late.

  5. Roger Brownon 03 Sep 2008 at 11:09 am

    It is not really clear that a steady rise in oil prices would be a good thing. A steady predictable rise in prices would aid in the financing of capital intensive, dirty alternatives such as coal to liquids, heavy oil, tar sands, shale oil, and even electric cars which, in a struggling economy, will be primarily powered by the cheapest available fuel: coal. On the other hand in a atmosphere of extreme price volatility such capital intensive techno ‘fixes’ would have trouble getting off the ground. In fact extreme price volatility might wake people up to the virtues of voluntary simplicity:

    Wait a second. Demand goes down and price goes down. If we deliberately reduced demand we could put an end to this chaos.

    I am not overly hopeful of about the emergence of a politically meaningful movement toward voluntary simplicity in the near future, but if we do not eventually figure that endless growth in a finite world is bad idea then our future on this planet is going to be extremely bleak.

  6. Kation 03 Sep 2008 at 12:46 pm

    My husband’s one of those “well, I TOLD you the price would come back down” types, but I keep reminding him that every time it comes back down, it only comes down by about half of what it was prior to the rise. About the time we get used to that “lower” price being the norm, it spikes again. I’m guessing that next time it spikes, it will hit 5 dollars a gal., easily. We’ll all freak out, till the price drops again, to about $4 per gal. We’ll get used to the $4/gal. (which seems incredibly high right now), then the next spike will hit probably about $5.50/gal…… Drop to $4.5, we’ll acclimate to that….. The spikes are getting progressively higher, the norms, progressively higher. I’ve been telling my hubby this for almost 4 years now. His dad is finally seeing what I’ve been seeing. The hubby still refuses to open his eyes. (Which, is particularly scary to me considering that he usually takes his dad’s word as gospel. But this time, he’s ignoring even his dad, while I’m happy that his dad is finally starting to see the trend I’ve been seeing (and have been reading about from folks like you and JHK) for 4 or so years.)

    However, even as ostrich-like as my hubby is being, he’s made some changes that I think will be a little more likely to stick, no matter WHAT happens to the price of oil: more willing to help me with gardening tasks; driving less and using our old “beater with a heater” for more of that driving instead of his gas-guzzling truck; taking interest in the upkeep and betterment of our house….. I think that ultimately, some of the changes folks have made to their lifestyles will stick, no matter what happens in the “financial world”, or to the price of oil. It happened with the Great Depression, it happened in the days of the hippies, and it’s happening again this time. It’s something, anyway.

  7. Fernon 03 Sep 2008 at 1:04 pm

    I looked at a chart of the CBOE oil prices, did a little ‘technical analysis’. Today’s price is just about testing lows from February this year - just THIS year. If you go back two years, it’s just at the bottom of that trendline. Sure, this is a significant dip in oil prices. But the chart shows that percentage wise, we’ve had dips like this before.

    And after the dip, yes, the price of oil always makes it’s way up to new highs again. Often after a ‘false’ rise and fall in price is seen.

    Volatility is going to be the word for the future. In weather, in oil prices, etc.

  8. Steve in Coloradoon 03 Sep 2008 at 4:19 pm

    To answer your question:

    “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”

    You’re quite right about this. The problem is that no one (present company excepted ;-) seems to remind these folks that they were saying the same thing after Katrina, when gasoline first went over $3 per gallon and then came back down. Are they happy with their decisions back then regarding energy use now? Do they really think it will be any different this time, or will they be saying the same thing when the price of gasoline finally pulls back below $5 per gallon a year or two from now, and after the pullback from $6 and $7 and $8 per gallon.

    Most folks in our society are not “geared” to look for the longer term. For better or worse, those that are able to see bigger are usually fustrated in trying to get people without this ability to see the bigger picture.

  9. AVon 03 Sep 2008 at 4:57 pm

    Sharon,

    Very well put. It was less then a year ago that the idea of oil over $100/barrel was cause for alarm. Now gas below $110 is cause for celebration? That makes no sense.

    I could see oil breaking below $100 briefly but the winter demand will kick in soon and then we will see a gradual rise in price. This rise will be rarely commented on until it closes on the current high of $150 and then we will see attention and speculation that will drive the price up again. Lather. Rinse. Repeat.

    The problem is that we are chasing a decline curve. Every time our decline in demand catches the supply the supply will sink a bit more (or to be more precise supply will get that much harder and more expensive to fulfill). We will go from light sweet crude, to heavy sour, to shale oil, tar sands and coal liquefaction and then who knows what.

    I see that one of the networks is doing a peak oil special that they are promoting with a tag line something like “someday it will all be gone”. Tag lines like that make me nuts as that will never be true and it completely misleads people.

    AV

  10. Veganon 03 Sep 2008 at 5:18 pm

    Declining oil prices can also be attributed to foreign investors buying more dollars due to declining world economies. Foreign investors seem to believe that the US economy/dollar will be the last one to go down in a global financial collapse.

    Ilargi (#) says, “… oil prices have so far dropped 25%. If investors keep buying US dollars into 2009, in a world economy bleeding ever more profusively, oil will undoubtedly slip back at least another 25%, and move back to $70-80 per barrel, or below.”

    I was hoping to see very high oil prices so that demand for oil would be curtailed and carbon emissions would be reduced. Clearly, deflation will reduce demand for oil as well.

    It seems like economic/financial collapse might precede severe effects from Peak Oil and climate change. Unless, of course, we get a category 5 hurricane (we’re dodging hurricanes in So. FL!) …

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