Neither Bull Nor Bear: The Joys Of Being An Oil Contrarian.

Although I don’t actively trade equities, when I have done it has typically been as a contrarian, partly because I’ve embraced the lesson of “devil take the hindmost,” that is, the last into a rising market or equity will be the loser, and it’s hard for casual trader to be first in.  Which probably makes me more accepting of the role of short-sellers than many others, especially those being sold short.

Like so many things, short-sellers have their good and bad sides.  Actively trying to drive down an equity that you have shorted seems at best distasteful; however, trying to analyze corporations to see if they are overvalued provides an important service to the market, specifically price discovery.  Corporations rarely distinguish between the two types of actors and dislike both, although it’s only the former who deserve our approbation.

It has long been noted that investment banks and companies prefer bullish commodity price forecasts, the former because there’s more business selling stocks to clients than advising them to sell their holdings (all clients can buy, but only those holding equities can sell), while commodity producers naturally prefer to think their revenue prospects are bright due to rising prices.  This bias generally seems to hold true for punditry as well:  many audiences want to hear the good news story.

For over four decades, I have been a contrarian about energy prices, usually with the lowest long-term forecast for oil and natural gas and most optimistic supply expectations, and I have been frequently chided for my views.  Indeed, my relatively moderate forecasts are usually judged as beyond the pale.  For example, in 1989, the Petroleum Economist referred to my prediction that oil prices would not keep up with inflation during the 1990s as “heretical.”  In 2012, at OPEC, an oil company CEO, asked if he believed my prediction that prices would fall from $100/barrel to $50-60, said, “Well, you hate to call someone an idiot.”  And in the 2014 DOE oil price forecast survey, I came in way below everyone else, to the point where someone said, “They asked me, ‘Is he drunk?’”  In those cases, I was more or less prescient and the consensus was wrong.

[Note:  I have had many bad price forecasts, especially in the 2000s, when I anticipated that prices would soon decline, partly given my expectations of mean reversion.  I also thought that surely the Iraqis, given their huge oil resources and desperate financial needs, would quickly pass a petroleum law and raise production.  Silly me.]

There are a lot of reasons to be a contrarian, most of them not very appealing (as far as I’m concerned).  First, it seems pretty clear that in many debates, people are driven by both their biases but also their psychological nature.  Some are simply pessimistic about oil supply, for example, and others foresee market trouble around every quarter.  The casual observer might not realize that the analyst has predicted summer power blackouts or shale oil production collapses year after year throughout their career.  As Led Zeppelin would say, “The song remains the same.”

Gaming the system is another reason to adopt a contrarian position:  a pundit stands out only if he or she adopts a view different from most others.  If you agree with the consensus and are proved right, nobody notices.  If you disagree and are proved right, you obtain bragging rights.  (Except since you will have presumably been wrong other times, there’s no guarantee you can convince the casual observer that your analysis is superior.)  It’s kind of the old story about the two hikers who are suddenly charged by a grizzly bear.  When one stops to put on sneakers, the other says, “You can’t outrun a grizzly.”  And the second responds, “I don’t have to outrun a grizzly, I just have to outrun you.”

Case in point:  Working with M.I.T.’s Nazli Choucri, I helped produce an oil price forecast for Stanford’s Energy Modeling Forum in 1980 (labelled IPE), which proved to be absolutely horrendous, as the figure below shows.  Except compared to all the others.  (John Mitchell of BP had the best forecast:  he predicted flat real prices.)  I often tell students that, someday when they get in trouble for a bad forecast, they can tell their boss they saw someone brag about a 140% error.

The media’s habit of presenting balance can be part of the problem, with their tendency to want to show “both sides” of the debate without judgement or even serious analysis.  Which isn’t to say that they should try to maintain track records of forecasts (which would embarrass pretty much everyone), but that observers shouldn’t take a media story as evidence of the validity of an argument.  Not that the general public is any better.  I’ve had any number of people praise a presentation on mine, when all they could recall was the opening joke.

Contrarians are most useful when they question the reasoning behind a consensus, rather than simply disagree with it.  So, when the industry was saying, “The easy oil is gone,” my point was that it seemed to have disappeared suddenly and at the time of supply disruptions in 2002/3.  Holy smokes, what a coincidence!

The historical experience for resources like oil is that change is gradual—except where politics removes or adds large amounts of supply.  Resource nationalism in the 1970s, for example, tightened the market, but was reversible (and reversed).  The gradual depletion of oil globally since 1859 has not driven up prices; only external disruptions have.

Which highlights one major value of contrarians, namely, a willingness to be unfashionable.  In the 1970s, when many were declaring that the age of oil was over, contrarians like M.I.T.’s Morry Adelman and Peter Odell of Erasmus University correctly pointed out that the problems were all transient in nature, not physical.  The Iranian Revolution removed large amounts of oil from the market, but had nothing to do with resource scarcity.  Price bears like them were regularly mocked.

Similarly, when oil prices soared in the 2000s and the consensus seized on the ideas of a) peak oil; b) depletion of the ‘easy oil’; c) a floor price of $100, and d) a new paradigm or market regime.  None of these held up under serious inspection, but few undertook serious inspection. (My book debunking peak oil sold far less than the superficial accounts of the end of the oil age, like James Howard Kuntsler’s The Long Emergency, even now rated well above my book on Amazon despite being a decade older.)

Of course, ‘fashionable’ is both a bit subjective and easier to spot in hindsight.  In the 1990s, there was a surge in interest in hydrogen fuel cell vehicles and huge amounts of money invested by the automobile industry, although it should have been clear that the technology was nowhere near viable.  (Two decades later, it’s still not ready for prime time.)  The problem is that fashion, or popularity, often reduces scrutiny due to the assumption that the popularity is the result of the judgement of others, without realizing that judgement might not reflect economic viability.

Ultimately, listening to pundits becomes a case of caveat emptor, let the buyer of information beware.  Determining that a given speaker/writer is psychologically contrarian as opposed to smarter than the average bear requires thoughtful consideration of the arguments being made.  Sound bites on cable news or even blog posts (like this one) are of only so much utility.  Lengthy presentations and research papers, especially those that consider opposing viewpoints, are likely to be more valuable than short posts and tweets.