[extropy-chat] Peak Oil news

[Hal Finney]

Samantha Atkins writes:
> The markets, as anyone who plays them knows, are not altogether  
> rational.  So I find it unlikely that examining market price  
> structures will give good evidence for or against Peak Oil.

Yes, the markets are the worst predictors around.  Except for everything
else. :-)

The reason markets are a good source of information is so obvious that it
never seems to be written down.  Unlike other opinions, market opinions
are backed up by the hard-earned cash of the people asserting them.
Taking a position in the market forces you to think hard about your
assumptions and to judge whether you are really as confident in your
opinions as you think you are.  The fact that someone is always there to
bet against you is an ever-present warning that maybe he knows something
you don't.

It's easy to go out and say whatever you want, make whatever predictions
you want.  A few months ago I posted about this New Yorker review of a
book on how bad a job "experts" do in predicting:

http://www.newyorker.com/critics/books/articles/051205crbo_books1

One sample quote:

> People who are not experts in the psychology of expertise are likely
> (I predict) to find Tetlock's results a surprise and a matter
> for concern. For psychologists, though, nothing could be less
> surprising. "Expert Political Judgment" is just one of more than a
> hundred studies that have pitted experts against statistical or actuarial
> formulas, and in almost all of those studies the people either do no
> better than the formulas or do worse...

I seem to recall reading something about the theory of market consensus
that is quite dramatic.  I'm probably remembering it wrong at least in
part, but I'll present it for your consideration.

Suppose you have a belief about some future event, and then you are
informed of the market consensus and it is very different from your
belief.  For example, many Peak Oilers agree with oil analyst Matthew
Simmons that oil will be over $200 a barrel by 2010.  Simmons made a
famous public bet about this a few months ago.

Now, the oil futures market price for 2010 oil is about $64, a big
difference from $200.  Once you find out about this discrepancy between
the market consensus and your beliefs, you have two choices.

One is to change your belief to match the market consensus.  This is
what I aim to do.

The other is to accept that there are positions you could take in the
market, bets you could make, that have a positive expectation.  That is,
you have to believe that the markets are giving away free money.  And
the more divergent your beliefs are from the market, the easier it is
to find such positions and the greater the profits.

Right now, for $5,000 you can buy a $100 call option that expires in 2010.
This will be worth 1,000 * (oil price - $100).  So if oil does in fact
go to $200 as those people believe, their $5,000 option would be worth
$100,000, 20 times their investment.  And they'll actually make a profit
as long as oil goes above $105.  If they think that $200 is likely,
presumably they think that $105 is a sure thing.  So for almost no risk
they have an investment that has a good chance of making them 20 times
their money.  That's a heck of a deal!  It's like a lottery ticket where
you're almost sure to win.

That's how the world has to look to people who choose to disagree with
markets.  They are forced to believe that there are free lunches on every
corner, i.e. that they can get 20 times their money risk-free.  In a way,
they're very lucky people, to live in such a world.  Wouldn't you like
to live in a world like that?

Most people with these beliefs don't actually try to participate
in the markets.  I see this as irrational, to not take advantage of
free money.  Now, granted, there are some practical difficulties with
opening commodities accounts, and not everyone has $5,000 to invest.
But I don't think that is the real reason people aren't taking advantage
of these offers.  I suspect that people are fundamentally being irrational.

In fact, I believe that at root, it is not rational to hold a different
position from the market consensus.  This is what I was referring
to above, my dim understanding of an economic theorem.  To disbelieve
in the consensus is to believe in a world where money grows on trees,
and yet (for most people) not to take it.  There's something seriously
inconsistent with this way of thinking.

As I put it to the guy who believed in Simmons' $200/barrel, his belief
implies a risk-free expectation of 20-fold profits.  That sounds too good
to be true.  And as they say, when something sounds too good to be true,
it usually is.

So I would not be too quick to disparage the market consensus.  There is
sound logic behind it, and few if any institutions apply the same
discipline and motivation to people making forecasts.

Hal