[extropy-chat] Re: peak oil debate framed from a game theory standpoint ?

[Hal Finney]

The problem with the predictive ability of futures markets isn't with
the markets, it's with that darn future.  It's just hard to predict.

Right now, for example, who knows what oil prices will be, say, at
the end of next year?  The futures market estimates $65.65, about the
same as today.  By looking at options prices we can get an idea of the
degree of uncertainty, and I have recently learned this art.  The market
sees about a 21% chance that it will be at 80 or above, and about a 22%
chance that it will be 50 or below.  That's a pretty broad range, with
lots of uncertainty.

The future is inherently uncertain, so we should not be surprised that
that institution which specializes in extracting and consolidating
all available information in the form of prices, also reflects this
uncertainty.

One way to think of it is that we live in one of many possible worlds.
There is a world where oil will be $80 at the end of 2006.  There is a
world where oil will be $50 at that time.  Which world are we in?  We
don't have enough information to know.

Are we even in a specific world where that future price is effectively
pre-ordained?  Maybe our consciousness effectively spans multiple worlds,
each with very different future prices of oil.  In that case there is
not even any meaning to the question of what the future price will be.
We can only describe the future with a probability distribution.  Well,
that's just a personal speculation of my own.

Brian Atkins points out that futures prices often mirror present day
events.  When Katrina hit, futures prices as far out as 2011 went up
and then down just like spot prices did, although to a lesser degree.
On the surface, this might seem irrational.  How could Katrina affect
what the price of oil would be six years from now?  The effects will
be long gone by that time.

The way I would explain this is that this does not reflect the impact
of Katrina on the coastline, but rather the impact of Katrina on
people's minds.  Futures prices reflect our best guesses at the future.
Every experience that we have informs our minds and changes our opinions
about the future.  When Katrina hit and we saw that devastation, it made
us realize how vulnerable our oil infrastructure is, and how easily it can
be disrupted.  This knowledge and realization caused us to revise upwards
our estimates of a fair price for oil, as far out as the markets go.

Then, a few days later, spot prices were back down, and so were futures
prices.  It was learned that despite the devastation, crude oil supplies
were not badly impacted.  The Strategic Petroleum Reserve, and similar
reserves overseas, were available to make up a temporary shortfall.  This
calmed the markets and brought down spot prices.

And it also provided new information which affected futures prices.
Traders learned that even a devastating hurricane can have only moderate
affects, that there are measures in place for remediation and cushioning
the blow, and that these measures work.  This caused them to revise
downwards their estimates of the damage even a devastating hurricane
like Katrina can cause, and so prices of 2011 oil come back down.

It might seem strange that new facts like these, that come in on a day to
day basis, can cause the markets to revise their opinion about the most
likely future to a considerable degree.  But that is just a reflection
of the tremendous uncertainty inherent in the future.  The markets
continually aggregate all of the information that is available and
extrapolate it forward.  This process tends to cause future prices to
move up and down in synchrony with present day prices.  That is the
explanation for the phenomenon Brian noticed.

One final point: my skepticism about Peak Oil is not due to a belief
that markets are always right.  It is easy to find cases where markets
are wrong.  Rather, my point is that markets are more likely to be right
than Peak Oil enthusiasts.  One of the biggest marks against Peak Oilers
is that they believe that their case is obvious.  They tend not to say
that the future is extremely uncertain and hard to predict, and that they
merely see a certain risk of Peak Oil among other alternatives.  Instead,
most of them are quite certain that Peak Oil is a serious risk and that
the evidence in favor of it is very plain and obvious.  The often resort
to conspiracy theories to explain the absence of wider support for what
is to them an open and shut case.  The government knows and is covering
it up to prevent panic, or Big Oil is afraid to let people know that
they will be out of business in a few years.

But if Peak Oil were really that obvious, market traders would know about
it.  Further, insiders would know about it and that would be reflected
in market prices.  The links I provided earlier to the Econbrowser
blog elaborate on this point.  Whatever else Peak Oil may be, it is
not obvious!

The more specific point I made with regard to markets (which are,
after all, up by a factor of two in the past year or so) is that the
price structure you would expect for a Peak Oil driven price increase
is different from what you see today.  You would see future prices being
higher than present day prices rather than vice versa.  Instead, if you
draw a graph of oil prices over time (I have never seen any such graph
but it would be easy to draw one) you would see prices rise gradually
until mid to late 2006 and then fall to considerably lower than present
day prices.  If market participants believed in a Peak Oil scenario, the
consensus would not be that oil in 2010 is going to be cheaper than today.
So I think it is clear that the futures markets, as they work to aggregate
all available information about the possible course of future prices,
are not considering the Peak Oil scenario as very likely.

Hal Finney