Black Gold

With the price of oil hovering around $140 per barrel, the commodity boom can no longer be ignored.

The price of oil is one area where I have been consistently mistaken and dumbfounded over the years. When it first peaked to $60 back in 2005, I openly told friends that I thought it would fall within the year. I even went so far as to investigate options for betting against its continued rise.

Mistakes are human and, though humbling, they are also one of life's gifts because they give us the opportunity to learn.

In the case of oil, what I missed over the last 2 years was that contrary to my naïve intuition, which suggested that oil would be mean reverting like other asset classes, oil's rise is being driven by at least a belief that the supply and demand dynamics have fundamentally altered.

Whether pointing to the industrialization and modernization of China and India, the excess consumption of Americans, or the growing global population, commentators have many options for identifying the "root" of a world where oil is demanded at a greater rate than even a decade ago. At the same time, with a rising Russia, a hawkish Venezuela, and an unstable Middle East, supply has become less certain. Furthermore, doomsday "peak oil" theorists have continued to clamour that we have reached Hubbard's Peak and that as a result we will literally start running out of oil sometime soon.

One reason I have continued to expect oil to decline is that I believe that the economics of scarcity is dynamic and reactive. In other words, I believe that technological innovation can help make previously scarce resources either obsolete (through innovative replacement), less important (through efficiency) or more abundant than we previously believed (through exploration and discovery).

I continue to believe that these factors will help to address the supply-side constraints when we look at the world's oil markets. However, the perhaps accurate market's assessment of the current future demand growth as well as the market's perception of supply issues have combined with the technical dynamics of the financial markets to create the rapidly increasing price of oil we have witnessed over the last two years.

This rise has been exacerbated by the failure of other asset classes, as investors have – like good sheep – chased the positive returns offered by commodities as other previous staples like real estate and financial companies have proved to be unreliable sources of income.

All of this leads me to believe that the price of oil will come down at some point, but given the difficulty in predicting the various factors influencing its rise (including the irrational behavior of herds) it is very hard to say when.

Now is truly a moment where the Keynesian axiom – the market can stay irrational longer than you can stay solvent – is being put to the test.

Positive side effects like a concerted (albeit sometimes insincere) embrace of alternative fuel technologies, a consciousness of consumption, and an awareness of our dependence on other nations make this situation more bearable than it otherwise would be.

However, the rising ticket prices at the airports may make $2.00 increase in gasoline prices seem insignificant as they threaten to slow down the very globalization that has driven demand to the point where it is today…

But then again, perhaps this is Mr. Smith's invisible hand and scarcity rearing its head.

Time will tell. Until then, enjoy your moped.


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