But What Does It Mean?

Dilbert’s pointy-haired boss once said, “When you come upon a big pot of crazy, it is better if you don’t stir it.”

Trying to understand oil prices falls into the “pot of crazy” category.

The chart shows the price of oil from 1861 to 2014 adjusted to 2013 dollars.

oil prices in constant dollars

Some of the changes make sense.

Beginning in 1858, Oil was discovered and exploited in Pennsylvania.  The early value was quite high because there were uses and just a small supply.  By the end of the civil war supply caught up to demand and prices fell sharply.

By the end of the 19th century prices were rising as the easily accessible oil in the North-East started to run out.  That was short lived however, because oil was discovered in Texas shortly after 1900.

Henry Ford’s model T came along in 1908 and sharply increased demand.  More oil was developed in Texas and by 1933, the Texas Railroad Commission began to control prices.  Wartime price controls followed somewhat later and throughout the ’50s and ’60s supply at low prices remained available. Again easy oil became more rare.

In the mid 1970’s OPEC noticed that they could exercise supply side muscle and they did.  Chaos, in the area of price stability, ensued.

It is tempting to try to draw meaning from a graph such as this, but it is foolish to do so.  Chaos is not really capable of meaningful analysis.  For instance 85% of all the prices lie within one standard deviation of the mean.  This is not a dataset that has meaning if you treat it as if it is normally distributed.  Trends and other ideas make no sense either.

The reality is that prices after 1973 are based on political expediency, arising from other equally unpredictable events.  For instance the sharp fall in the late ’90s coincides with the bond catastrophe in Russia.  Causation.  Maybe?   What does that mean now?

If I tell you that over the past 154 years the average inflation adjusted price for oil is $34.71, the median is $22.53 and the standard deviation is $27.30 will you be able to estimate June 2017 prices?  Not likely.  You would need to know demand, alternate technologies,  the future minds of the people who can alter production levels, and their reasons for doing so.

Oil is important and its price responds to non-economic variables. If you cannot assess those variables, you are likely better to avoid investments and plans where oil prices are an important element. Maybe just have a lot of capital and a very long time horizon.

Given current gas prices, the taxi business, trucking and airlines are much more attractive than the once were.  Should you jump in?

When assessing prices, try to understand meaning.  When meaning is invisible, probably you should avoid the matter entirely.

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: don@moneyfyi.com  

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