Kemp: Persistence Of Instability In The Oil Market
(John Kemp is a Reuters' market analyst. The views expressed are his own.)
LONDON, Sept 14 (Reuters) - Volatility has always been the defining characteristic of oil and other commodity markets, defying repeated attempts to stabilise prices.
Volatility is present at all timescales from seconds, minutes and hours to days, weeks, months and years ("Oil makes only one promise and that's volatility", Reuters, December 2015).
At the macro-scale, the oil market has been characterised since its inception in the 1860s by a series of booms and busts lasting for years at a time (http://tmsnrt.rs/2cqOZov).
Efforts to tame the boom-bust cycle through the control of prices and production have repeatedly broken down ("Crude volatility: the history and the future of boom-bust oil prices", McNally, due to be published in 2017).
Volatility appears to be an intrinsic quality of oil markets rather than an incidental problem to be solved through improved forecasting, management and coordination.
Traditional explanations for volatility focus on the low price-elasticity of supply and demand as well as long delays in investment and the backward-looking nature of price expectations.
But the concept of feedback loops borrowed from control engineering as well as the theory of complex systems can also help explain some of the endemic instability in the industry.
In Constant Crisis
"There is always too much or too little oil," economist Paul Frankel complained seven decades ago ("Essentials of Petroleum", Frankel, 1946).
The industry has "an inherent tendency to extreme crises" because production and consumption are not "self-adjusting".
Frankel blamed the lack of smooth adjustment on the limited responsiveness of supply and demand to moderate changes in prices, at least in the short run.
The result is "a price structure that allows for ups and downs which fail to bring relief from dearth or glut", Frankel wrote.
The industry is subject to "continuous crises" in which "hectic prosperity is followed all too swiftly by complete collapse".
Frankel's words, published just after the end of World War Two, are a perfect description of the subsequent boom and bust in oil during the 1970s and early 1980s, and again between 2004 and 2016.
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