Model, Model: Who's Got an Oil Market Model?Professor Ferdinand E. Banks
February 2nd, 2011
I had hoped to give a provocative lecture on the economics of nuclear energy at the forthcoming international meeting of the International Association for Energy Economics in wonderful summer Stockholm, but on the basis of what might happen in North Africa and the Middle East in the coming months, I suspect that I will be asked by the conference directors to fall back on one of my oil market recitals.
The problem is that I have no new model. Several years ago a former student of mine at the University of Grenoble (France), who had ascended to better days, gratuitously informed me that a long paper of mine on natural gas was of little value because of the absence of a "model".
I'm not sure that he was correct, however it was hardly an accusation worth a great deal of reflection on my part, and so I dismissed it with a condescending smile on my face. I knew then, as I know now, that the real world oil and gas market games, if I can call them that, have very little to do with the formal economics and econometric models of the kind I had to suffer when a graduate student, and which on later occasions I wore out my patience and vocal chords when teaching at a dozen universities around the world.
In his survey of non-cooperative game theory, Professor David Kreps (1990) says that a good test of the usefulness of game theory is to compare the forecasting success of economists who use game theory with the achievements of those who abstain. This sort of thing might involve persons who approach the future of oil prices via models, as compared to those who use basic business acumen, or for that matter street-corner common sense.
As Professor Kreps makes clear, this would not be a very easy experiment to carry out, but where oil is concerned, I think that we can go at least part of the way. For many years - if not decades - I was a fanatic reader and teacher of the learned energy literature, and of the huge number of papers on oil that I examined in the mostly unread economics journals that collect dust and take up valuable space in academic libraries, I can only remember a few that I felt inclined to recommend to my students.
I received a question about my cavalier demeanour from several of the students in my course on oil and gas economics at the Asian Institute of Technology (Bangkok), to which I replied that if they were desperate to read the kind of pretentious analyses in the kind of learned journals they encountered in their academic backgrounds, or would encounter later in life, they would have to do so without my assistance. I might have added that any curiosity they may have about oil market and oil prices would be completely satisfied by the highly relevant lectures I was giving, and which I expected them to learn perfectly.
But on the other hand, going back 15 years, I probably mentioned that best paper that I encountered on oil was by Richard Teitelbaum in the business publication Fortune (1995). Four multi-millionaires, and later billionaires, were cited as going 'long' in oil properties. These were Philip Anschutz, Marvin Davis, Carl Icahn and Richard Rainwater. Of this cash-strong foursome, Mr Anschutz declined to be interviewed, however I was informed that he was the kind of investor who preferred to let his money do his talking, since it was an open secret that he had participated in several big-ticket shopping missions in the oil and gas markets.
The other gentlemen were very much up front as to why investors should take a bullish attitude toward oil. In fact the late Mr Davis supplied one of my favourite quotations on this subject: "You don't have to be a cockeyed genius to see this coming." Mr Rainwater was also explicit about his estimate of the oil future: "The increased global demand paints a picture for me that doesn't have any other outcome. The price of oil is going to have to come up."
The interesting thing about these investors is that all of them were cognizant of the demand for oil that would be forthcoming in China and India, and long before this matter was considered a worthy topic for mainstream energy economics publications, conferences and those drowsy academic seminars where amateurs do their songs-and-dances while clutching their lightweight 'scientific' contributions as if they were the gold to which an English economist once compared them. Everyone is now talking about China and its requirements, but few observers realize that India is also going to have a huge appetite for oil. Any decline in the Chinese demand will be more than compensated for by the increase in Indian consumption.
The interesting thing here is that the four gentlemen mentioned above increased their activities in the petroleum markets when the price of oil was zooming down, and even Sheikh Yamani was informing anyone who would listen that oil would soon be in the same situation as the stones that he seemed to think were so valuable during the Stone Age. For readers who have forgotten, he was expressing his curious belief that oil exporters should sell their oil for bargain-basement prices, because substitutes for oil would soon become widely available.
As in my lectures in Bangkok and Paris (2010), I now insist that the key to the present oil market is the behaviour of OPEC. I promote that controversial belief every chance that I get, because with or without a model, that is the way things are playing out in the oil market just now. This outlook has been questioned by many participants in the forums to which I contribute, which immediately leads me to suggest that they examine the dynamics of the oil market in 2009. In that year, with the international macro and financial markets on the verge of a total meltdown, OPEC was able to bring the oil price back from 32 dollars per barrel to almost 70. No conventional model would have predicted that.
In summer Stockholm, where the curse of electric deregulation will still be threatening many households, and ruining some, lecturers at the energy meeting mentioned earlier will likely be examining half-baked academic constructions - or models as they are commonly called - that might feature a development of oil prices whose moderation will shield the global macroeconomy from another rendezvous with the brink of ruin. I think that I will abstain from these fantasies, and suggest that you do the same.
Banks, Ferdinand E. (2011). Energy and Economic Theory: Singapore, London and New York: World Scientific
_____. (2011). A modern survey of world oil: realities and delusions. To be published by UNESCO (Paris).
_____. (2010) Oil and economics theory: some chronological and mathematical aspects. Lecture given in Uppsala and Paris.
_____. (2006). Logic and the oil future. 'Energy Sources'.
_____. (2000). Energy Economics: A Modern Introduction. Boston and Dordrecht: Kluwer Academic.
Kreps, David M. (1990) Game Theory and Economic Modelling. Oxford: Clarendon Press.
Teitelbaum, RichardS. (1995). 'Your last big play in oil'. Fortune (October 30).
Professor Ferdinand E. Banks
February 2nd, 2011
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