E All The Leaves Are Brown And The Data’s Gray

Making Sense:

Humans are funny creatures. When faced with all kinds of evidence to the contrary, humans tend to cling onto what is familiar, to what they have been taught or to their ideological viewpoints. The ability of humans to deny reality is amazing. Even when the evidence makes denial nearly impossible, humans lean on their last crutch, mean reversion. This is especially true of the financial industry. In our industry, it is not enough to be accurate. It is not even enough to be optimistic. One must be optimistic in a way which calls for a return to familiar conditions. Humans will wait and wait and wait, until either the law of averages brings around a return of the mean or until a scapegoat can be found. The problem is, when the world transitions from one era to another, mean reversion becomes problematic, if not impossible. In such a scenario, it is the “clingers” who often end up as the scapegoat.

Denial: It is not a river, but it can drown you

Oil, not your father’s commodity: For the last 50 years, oil has been mainly dominated by one cartel, OPEC. When OPEC cut production, oil prices increased. When OPEC increased production, oil prices fell. OPEC was the swing producer as there were no large-scale alternatives. Since OPEC is comprised of nations with national energy policies, the global price of oil was, more or less, centrally planned. Yes, oil trades freely in the commodities market, but its trading baselines were set by a cabal of foreign governments dictating supply.

North American oil production changed all that. Yes, North Sea and other global oil sources have existed for decades, but individually they paled in comparison with OPEC production, were uncoordinated and production was also set by governments via national energy policies. North American crude oil production changed all that. In the new era of oil, North American oil production is set by the private sector. Fixed costs, debt service and profit motive (at the company/investor level) drive production in North America. Unlike other OPEC alternatives in the past, North American production has the capacity to become the so-called swing producer.