There is a trading opportunity here, because oil prices will actually increase over the next 10 years but that is not (yet) predicted by financial markets.
Oil prices will increase in the long term, but not in the next 10 years
Other explanation of the investors’ expectations for 2033 is that they have seen the words “peak oil demand” written more and more frequently in the latest reports by IEA and other energy forecasters.
Oil demand can decrease by a combination of economic slowdown and oil intensity improvement. Oil intensity defined as the volume of oil needed to produce a fixed economic output. If we replace oil by other energy sources or increase the efficiency of our energy use we will improve the oil intensity. If we improve the oil intensity fast enough then we won’t see a significant economic impact. I guess the main point of Corentin’s argumet is about the speed of this transition.
Years ago, I read a paper explaining why oil price can’t go above a certain threshold. Oversimplifying it, the economic system can’t work above a certain cost of energy, so when this level is surpassed, some business will stop being profitable, the demand for oil will decrease and prices will go down. I might be missing some nuances and probably I’m not explaining it completely accurate, but this is how I understood it.
I would love to find the paper again to go through it, but unfortunately, I can’t recall the title nor the authors. I wonder if someone here have some references about the topic of how expensive an oil barrel can become before demand starts to shrink.
I further note that liquidity in these far-out oil contracts is quite low (though not zero). My belief is that if you tried to trade them very far away from the prices in the link above (say, at 2–3X higher), someone would trade with you at size; but I could be wrong about that.
There are several reasons for that described in the link, but one is that the price of oil does weird stuff :
Relationship between oil price and oil production. Jancovici, based on data from BP statistical review. There’s another chronological graph at the beginning of post 2.
There was an interesting video on that, but it was in French. There’s the expectation in economics that a resource that is getting scarcer will see progressive increases in price (Hotelling’s rule). However, it doesn’t really seem to work that way in reality—especially for oil. Something as obvious as a continuous price increase would be immediately picked up by markets—so it just doesn’t happen.
There are many considerations to take into account in addition to rarefaction—the price of oil also depends on what the perceived reserves are, the expectations of what the demand will be (there’s indeed some talk about “peak demand”), what the OPEP does or says and what it’s actual reserves are…
Plus, right now, there’s a lot of tension with the Covid recovery and the fact that imports from Russia are disrupted—it’s possible that markets expect that once the situation stabilizes, the price will be lower.
Anyway, I think nobody really knows what the price of oil will be in 10 years (and I guess most attempts to guess the price in 2010 failed). The IEA systematically failed to guess oil prices over time. So I don’t expect financial markets to guess the correct price. Their incentives are more short term than that.
Well, I’m certainly not trying to suggest that you can look at the price of futures and tell exactly what the price will be in 10 years. But I would expect the price of 10-year futures to approximately capture all known information, including the factors you mention, those mentioned in the essay, and more. My understanding of the argument in the OP essay is that we should expect oil to be very expensive in the medium term, and if you think that is true then the efficient markets hypothesis should apply. Do you disagree with that? And how, exactly?
As for your remark about the IEA estimates, I note that these forecasts are not tradable and not subject to the efficient markets hypothesis. Is your claim that oil futures systematically under-price the future price of oil? Though even if that were true, I don’t think it contradicts the markets based argument, since predictions about (and risks of) future price changes are not necessarily symmetrical.
If we are debating expert predictions though, then I should point out that experts have also consistently and falsely predicted the coming arrival of peak oil supply.
I notice that financial markets are pricing crude oil futures for delivery a decade from now lower than for delivery next month. https://www.cmegroup.com/markets/energy/crude-oil/light-sweet-crude.quotes.html
Do we think that:
There is a trading opportunity here, because oil prices will actually increase over the next 10 years but that is not (yet) predicted by financial markets.
Oil prices will increase in the long term, but not in the next 10 years
Something else?
Other explanation of the investors’ expectations for 2033 is that they have seen the words “peak oil demand” written more and more frequently in the latest reports by IEA and other energy forecasters.
Oil demand can decrease by a combination of economic slowdown and oil intensity improvement. Oil intensity defined as the volume of oil needed to produce a fixed economic output. If we replace oil by other energy sources or increase the efficiency of our energy use we will improve the oil intensity. If we improve the oil intensity fast enough then we won’t see a significant economic impact. I guess the main point of Corentin’s argumet is about the speed of this transition.
Years ago, I read a paper explaining why oil price can’t go above a certain threshold. Oversimplifying it, the economic system can’t work above a certain cost of energy, so when this level is surpassed, some business will stop being profitable, the demand for oil will decrease and prices will go down. I might be missing some nuances and probably I’m not explaining it completely accurate, but this is how I understood it.
I would love to find the paper again to go through it, but unfortunately, I can’t recall the title nor the authors. I wonder if someone here have some references about the topic of how expensive an oil barrel can become before demand starts to shrink.
I further note that liquidity in these far-out oil contracts is quite low (though not zero). My belief is that if you tried to trade them very far away from the prices in the link above (say, at 2–3X higher), someone would trade with you at size; but I could be wrong about that.
I’d argue that we’d be in the “something else” category.
I wrote a section here arguing that prices are not a good indicator : https://docs.google.com/document/d/1ripciOx0QeqZZsxYL80DnY5Vn6iXcTzdkffpSYOA52Q/edit#heading=h.73az53qro5he
There are several reasons for that described in the link, but one is that the price of oil does weird stuff :
Relationship between oil price and oil production. Jancovici, based on data from BP statistical review. There’s another chronological graph at the beginning of post 2.
There was an interesting video on that, but it was in French. There’s the expectation in economics that a resource that is getting scarcer will see progressive increases in price (Hotelling’s rule). However, it doesn’t really seem to work that way in reality—especially for oil. Something as obvious as a continuous price increase would be immediately picked up by markets—so it just doesn’t happen.
There are many considerations to take into account in addition to rarefaction—the price of oil also depends on what the perceived reserves are, the expectations of what the demand will be (there’s indeed some talk about “peak demand”), what the OPEP does or says and what it’s actual reserves are…
Plus, right now, there’s a lot of tension with the Covid recovery and the fact that imports from Russia are disrupted—it’s possible that markets expect that once the situation stabilizes, the price will be lower.
Anyway, I think nobody really knows what the price of oil will be in 10 years (and I guess most attempts to guess the price in 2010 failed). The IEA systematically failed to guess oil prices over time. So I don’t expect financial markets to guess the correct price. Their incentives are more short term than that.
Well, I’m certainly not trying to suggest that you can look at the price of futures and tell exactly what the price will be in 10 years. But I would expect the price of 10-year futures to approximately capture all known information, including the factors you mention, those mentioned in the essay, and more. My understanding of the argument in the OP essay is that we should expect oil to be very expensive in the medium term, and if you think that is true then the efficient markets hypothesis should apply. Do you disagree with that? And how, exactly?
As for your remark about the IEA estimates, I note that these forecasts are not tradable and not subject to the efficient markets hypothesis. Is your claim that oil futures systematically under-price the future price of oil? Though even if that were true, I don’t think it contradicts the markets based argument, since predictions about (and risks of) future price changes are not necessarily symmetrical.
If we are debating expert predictions though, then I should point out that experts have also consistently and falsely predicted the coming arrival of peak oil supply.