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Energy , ETFs

Oil Prices Vs. Production: Here's the Connection That Most Observers Ignore

If production drives prices, how does oil rise 14x when production trends sideways for 10 years?

by Bob Stokes
Updated: October 17, 2018

There's a widespread assumption that supply and demand drives oil prices. Almost all economists base their oil forecasts on this premise.

If the oil industry ramps up production to increase supply, economists expect a drop in oil prices. If production is decreased, they anticipate a rise in oil's price.

Factors that are supposed to impact production are many. Let's consider the less obvious one, like the case of the Saudi journalist who went missing after entering the Saudi consulate in Istanbul on October 2.

You probably know that the Trump administration threatened severe punishment if it's learned that the Saudi government was behind the murder of the journalist.

Here's how a Saudi "official" responded to this threat of punishment (CNN, Oct. 15):

[The] general manager of [a] Saudi-owned news channel... warned that any sanctions would lead to the kingdom's "failure to commit" to specific levels of oil production and "if the price of oil reaching $80 angered President Trump, no one should rule out the price jumping to $100, or $200, or even double that figure."

The reasoning in the news item is that U.S. sanctions against Saudi Arabia would mean a cut in oil production. In turn, this would mean higher oil prices.

Again, this is the conventional viewpoint.

However, EWI has found that just the opposite is true: Oil production follows price. When prices rise, so does production, and vice versa.

Consider this graph and commentary from EWI founder Robert Prechter's 2017 book, The Socionomic Theory of Finance:


Supply-demand theorists glance at this graph and declare that the trend toward more U.S. oil production caused oil's price to fall. But the claim does not bear scrutiny. How does one get a 14-times rise in the price of oil out of the perfectly sideways production trend from 1998 to 2008? It seems a bit extreme. Oil prices then crashed before the volume of production emerged from its historical range, an event that doesn't fit the mechanics paradigm. Finally, it is outright impossible to account for the fact that oil prices tripled as production surged from December 2008 to May 2011 and held up for three years thereafter as production continued to expand.

Rather than a change in supply dictating a change in price, the chart shows one thing unequivocally: that a change in price ultimately encouraged the discovery of a new source of supply.

This is not to say that supply and demand factors don't matter. A sudden burst of a major pipeline can send oil prices higher. Yet, specifically, to base one's long-term oil forecast solely on rising or falling production means to ignore the chart above. It shows you what a huge role market psychology plays in price formation.

Elliott wave analysis helps you predict market psychology, and where it's likely to take oil prices next.

Indeed, the same applies to all financial markets. Get our latest insights now.

"Supply-and-Demand" Oil Myth: BUSTED!

Here's the myth: Oil prices are driven by supply-and-demand.

Know this: The historical data contradicts this widely held belief -- repeatedly.

Yet, the historical record DOES show that the chart pattern of oil does follow the Elliott wave model.

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