The Oil Drum

There is an old vaudeville skit that has an actor (Annie) come on stage behind the M.C. and begin visibly searching the floor of the stage. “What are you doing, Annie?” asks the M.C. “Looking for my ring,” she says. So they both start to look over the floor. After a while the M.C. looks at Annie and asks “Where did you lose it?” “Backstage,” says Annie. “Then why are we looking for it out here?” asks the M.C. “Because it is too dark to see backstage,” says Annie.

I was reminded of this skit as I watched a ”panel of experts” on the PBS News Hour with a couple of energy analysts talking about petroleum economics, and the cause of the current price rise. Their reasons (one blaming it in part on the Federal Reserve decision to cut interest rates) related to their areas of expertise and knowledge in the Commodities Markets. It is a common failing. Experts will try and explain events or seek to control events, based on their what they know and are comfortable with discussing (where it is light), rather than necessarily going to the root cause of the problem (where the ring was dropped). It is a fault both of those who select the experts to give an opinion, and the focus of those experts, and where this approach is used extensively it tends to hide the nature of the true problem from the public, in the obfuscations of those who are comfortable only when turning the question to allow answers that relate to subjects they know about.

A good many years ago, I read George Soros' "The Alchemy of Finance", which introduced me to the concept of reflexivity, which in a nutshell is when observers of a phenomenon can't help but impact the phenomenon itself via their 'observing', thus changing the original underlying fundamentals and setting in motion a boom-bust dynamic (i.e. more exaggerated trends in both directions). Since Mr. Soros recently spoke to Congress regarding the oil futures market 'bubble', I thought I'd take a closer look at the concept of reflexivity, both as it relates to oil and commodities in general, as well as its broader implications for efforts in raising awareness of global resource constraints.

This is a guest post by Shunyata. Shunyata is a manager of financial derivatives with training in financial engineering, actuarial science, statistics, and mechanical engineering. While he does not work directly with commodity markets, his background in financial engineering gives him insight into the operation of oil markets that may be helpful.

The observations below represents Shunyata's opinions based on his study of commodity derivatives to protect his personal interests. Commodity derivatives are exceedingly complicated, and his direct expertise is with respect to financial derivatives. This post is not intended to represent investment advice.

What Can the Commodity Market Tell Us about Peak Oil?

Market Consensus

A common view is that market prices reflect the market consensus about future prospects. This is a dangerous misunderstanding from several standpoints.

Consensus is an equilibrium statement, but equilibrium is non-existent in reality. There is the obvious problem of new information constantly disrupting the market. More importantly, the market contains a hidden, complex structure of players:

• There are large, in-the-know entities who act opportunistically, seemingly at random;

• There are hedgers who react to market moves mechanically and in unison (no disparagement intended);

• There are diverse small players who respond slowly in diverse ways, etc.

Venture capitalists look at alternative energy

Investors in start-ups are expected to pump even more money into energy ventures in 2007 after doubling their bets last year amid shifting politics and global-warming worries.

Venture-capital firms poured $536 million into biofuel and other energy ventures in the first three quarters last year vs. $224 million in all of 2005, said industry tracker Dow Jones VentureOne.

Last year's gain came as overall VC investing rose a smaller 9.7 percent, to $19.5 billion, from 2005's comparable three quarters. The rise also dwarfed the figure five years before, when investors flocked to energy during California's electricity crisis, only to cut back after the crisis passed.

Now, VCs are returning to the sector, following a "sea change" of interest in alternatives to conventional energy sources, said John Denniston, a partner at Kleiner Perkins Caufield & Byers.

[editor's note, by Super G] From the contributor formerly known as thelastsasquatch.

Fossil fuels comprise the largest commodity markets on the planet. In a world facing an upcoming date when it will have used 50% of its oil (and natural gas), interest in energy futures will continue to increase. And, as energy becomes more precious vis-à-vis dollars, the activity in the futures markets, particularly for crude oil and natural gas, will have increasing impacts on society. Indeed, the amount of finite oil that can be financially controlled by a near infinite amount of money is enormous. The following is a basic primer on energy futures and will be one of several foundational posts linked to a longer upcoming story, "Peak Oil, Investments, and Diversification". I will outline the basics of an oil futures contract, and discuss the risks and rewards of investing in energy futures. The post will conclude with a discussion of the growing paradox between money and energy.

Waiting for the Crash in Commodities:

The bull market in commodities, now in its fifth year, is beginning to challenge the laws of physics. Prices as measured by the Reuters/Jefferies CRB Index have not staged a rally this long in more than 50 years.

As someone said elsewhere, "the inability of economists to grasp the finite nature of non-renewable commodities never ceases to amaze me." Discuss.