Oil Prices Vs. Production: See the “Elephant” Almost Everyone Ignores
If production drives prices, how does oil rise 14x when production trends sideways for 10 years?
by Bob Stokes
Updated: March 27, 2018
There's a widespread assumption that supply and demand drive oil prices. Almost all economists base their oil forecasts entirely on this premise, and so do many speculators.
If the oil industry ramps up production and increases supply, economists expect a drop in oil prices. If production decreases, or some other factors hint at supply constraints, they anticipate a rise in oil's price.
A case in point is this March 23 CNBC headline:
Trump security pick John Bolton likely to turn up heat on Iran and boost oil prices
As you may know, Bolton is considered to be "hawkish" toward Iran, so the thinking goes that a ramping up of U.S. sanctions against the nation could hamper Iranian oil production or Iran's ability to sell oil on the open market.
It may very well turn out that oil prices do move higher, but, according to our research, production is not everything.
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. This history of behavior mercilessly mocks the ubiquitous assumption that changes in the supply of oil determine changes in its price. Yet no one seems to notice.
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. The huge, 14-times rise in the price of oil from 1998 to 2008 prompted U.S. oil producers to step up exploration, which ultimately led to new production.
So, if you're an oil trader, basing your trading decisions on the traditional supply-demand model may do great damage to your portfolio. Supply and demand factors do play a role in price formation, but they are far from being the only factors.
The trend in collective psychology of speculators, reflected by Elliott wave price patterns on oil's price chart, govern oil prices to a much higher degree.
Indeed, the fact is that the Elliott wave model helped EWI call "every major turn in crude oil since 1993." It's a verifiable claim.
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