Op-Ed: Don't Forget the Animal Spirits

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By Kevin Grant McClernon

U.S. oil production is booming and global demand is cooling. That is the story, at least. But when you look at the data – it just does not hold up. As of the end of 2014, daily supply exceeded demand by 800,000 barrels per day in a market that consumes more than 92 million every day. The world is producing only .85% more oil than we are consuming. Are we really to believe that such a minimal “oversupply” has resulted in a nearly 60% drop in oil prices? If traditional supply and demand cannot adequately explain the seismic shift in prices, behavioral economics might.

Daily Production Consumption +/- (+ is excess)
2013 90.90 mm 91.24 mm  - .34 mm
2014 92.94 mm 92.13 mm    .81 mm

If the numbers do not add up, there must be other exogenous factors influencing prices. What are they?

Fear, anxiety, and uncertainty - as Professor “Chud” Chuderewicz would say, animal spirits. The market reaction has as much – if not more – to do with people’s emotions than it does with fundamental economics. Investors just want information. They want to know who is going to win. They want to know if Saudi Arabia will stay on top. They want to know if America is for real. They want to know how long this battle will last. Uncertainty in financial markets creates hysteria. It produces emotional responses. It drives people to make judgment calls on the spot that may not be fully informed. And passive investors get caught up in the mix. It is psychology that says we like to follow the crowd.

Sometimes our “fight-or-flight” reactions get the best of us. But maybe we should just look at the fundamentals. Does this “oversupply” of less than 1% really justify the wild drop-off we’re witnessing? Or are we just scared?

Editor’s Note: This piece is one of two op-eds framed around the question, “Do Market Fundamentals Explain the Oil Price Decline?”  It takes the negative position. To read the opposing view, please read "Supply and Demand Are Guilty Until Proven Innocent" by Camille Mendoza.

Sources

http://bit.ly/1mKT7dF

http://1.usa.gov/ZmwTud

http://1.usa.gov/ZmwTud