Oil as a Trap of Rational Interpretations


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Sergei Golubitskiy

25 Nov, 2016

in Commodities

Well, let’s look at the following chart:


This is the history of oil prices traded at organised markets for the last 150 years. If we compare the price spikes with significant historical events, we will see that some of these events caused overwhelming rises (e.g. World War I, Energy Crisis of the 70s, Recovery after 2008 derivatives meltdown), others, contrariwise, led to collapses (Iraqi invasion of Kuwait in 1990), but most of the time oil prices just ignored social and political shocks (all the way through The Great Depression, World War II, Caribbean Crisis and Vietnam War).

Our inability to predict rises and falls of oil prices based on certain historical events is nonetheless compensated by another correlation implied by the chart. Any time a sharp move in oil prices occurs, the mass consciousness of market participants records a collective safety risk, arouses anxiety and causes strong reaction directed at returning things to normal.

Since the end of 90s the status quo of the oil market was associated with a constant rise in prices. That’s why the flash-like collapse caused by financial crisis of 2008 was quickly compensated by an even more impressive rise.

On the subconscious level the market always tries to bring the situation to normal. The only variable here is the notion of normal which changes in time and place. Today this normal envisions the oil prices at $100 and growing. Why? Because the concept of growth is the core of all modern paradigms of social development. Growing is normal, anything else is anomalous.

This propensity to the normal has no rational explanation that’s why appealing to the tankers queued at harbours, production levels, unsuccessful OPEC meetings or Cushing storage hub is meaningless. The driving force behind today’s oil flight from $27 to $52 is hidden in mythological perception of reality which in its turn demands the return to normal.

This is why it seems to us that the oil prices grow out of the blue. The same very reason supports our readiness to accept any rational explanation, even conspiratorial as soon as it sounds logical.

How long will the return to normal in oil prices take? It’s impossible to predict because we don’t know what will prevail — the evidence of negative factors (overproduction, overstock etc.) or thanatophobia of the trading crowd. We also cannot exclude the forthcoming of a black swan in shape of anything. e.g. afore-cited war.

One thing is clear: if nothing extraordinary happens and the present dynamics in oil production and consumption remains intact, the oil will continue its return to normal — $100 and higher — even without OPEC countries reaching any agreement on production cuts.

I’d like to draw a practical conclusion to this text which could be useful in trading and investing. It’s pretty obvious: since the mythological and irrational nature of the market’s psychology precludes us from predicting price fluctuations, we can achieve success in two other venues: parsing the reality in order to discover its current concept of normal and conforming our moves with the existing trends and not with their (inexistent) rational interpretations.

Sergei Golubitskiy can be contacted at EXANTE

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