The Oil Drum

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.

To the greatest extent in the history of oil futures trading, oil prices are now in continuous contango--that is, oil futures get progressively more expensive each year into the future. Does this mean that Peak Oil, as a meme, has "tipped"? Our latest oil price poll suggests that well over 70% of the sample (N>3000 now) thinks that oil will at least stay above $114 a barrel for the next two months--and almost half think it will hit $140 a barrel in that timeframe. Search volume on Google for the term is up dramatically in the past month, as is traffic at The Oil Drum. The following graph shows the dramatic swing from backwardation to contango over the last 6 weeks:

Has Peak Oil, as a meme, "tipped"? Our latest oil price poll suggests that well over 70% of the sample (N>3000 now) thinks that oil will at least stay above $114 a barrel for the next two months--and almost half think it will hit $140 a barrel in that timeframe. Search volume on Google for the term is up dramatically in the past month, as is traffic at The Oil Drum. One indicator of a "tipping point" for acceptance of Peak Oil may be the state of backwardation in oil futures. I first raised this idea over 2 years ago, but recent market movements, coinciding with attention in the press, may be validating it: when the markets accept Peak Oil, we will see the end of backwardation in crude oil markets, and possibly even Contango. Here's what has happened over the past 6 weeks:

UPDATE: Graph updated with data as of 10:00am EST on May 19th to show significant contango

(Note: permissioning issue for poll vote should be fixed) As 2007 draws to a close, not only did we observe a large increase in oil prices (approx 50% over 2006 year end), but we had a large absolute range in prices (approx $50). As mentioned in last weeks (less precise) poll, it is likely that many divergent forces will impact oil prices in 2008 (and in different directions). Oil rallied over $2 today, apparently on news of bombing in Iraq, this time from Turkey. Below the fold is an open thread to discuss upcoming volatility (or lack thereof) on oil prices in 2008. This poll will be followed by an end of year price forecast poll later in the week. But for a holiday appetizer, let's guess the volatility for 2008. Place your vote directly in the poll and put a comment with your vote and brief explanation in the thread - winner (if female) receives a date with highly eligible bachelor Professor Goose. If male, a congratulatory pat on the back...

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.

[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.

Jeff Vail asks the question: Is it possible that a shift in the crude futures market from backwardation to contango indicates that the markets have "tipped" and accepted Peak Oil?

More interesting ideas (and explanations) under the fold.