The plunge of commodities prices has caused some market participants and investors to take comfort in mean reversion. It is believed, by some, that once production is adjusted versus demand commodities prices should return to normal. Again, what is normal? If one believes the 2011 through 2014 was the “mean” for oil prices, the price of crude oil might be expected to revert higher. However if we take a longer view and acknowledge the impact of the incorrect (or premature) theory of “peak oil,” the mean might be much lower than one might believe:
Price of WTI Crude Oil since 1983 (Source: Bloomberg):
You tell me where the mean is?
Oil prices began to soar during the previous economic expansion as the housing bubble drove U.S. consumption higher and a rising emerging world pushed global oil consumption (more importantly, consumption expectations) higher, as well. It was believed by many economists and commodities market participants that there was little chance that global oil production could ever be increased sufficiently to meet warp-speed consumption growth. Two things happened on the way to peak oil. Apparently, high oil prices stirred animal spirits within the U.S. economy. The desire to profit from peak oil drove technological advances in oil (and gas) exploration, drilling and transportation. At the same time, the demand for oil grew at a slower pace than the markets expected. The result has not only been plunging oil prices, but also technological advancements to allow producers to turn profits at lower prices. Thus, mean reversion might not mean a return to “peak oil” prices. Maybe the “correct” price for oil in the current environment is $60 a barrel. Maybe it is $30 a barrel. Supply vs. demand conditions and global economic realities should determine oil prices, not historical precedent.
The plunge in commodities prices is hitting many emerging economies very hard. Rather than using the commodities boom years to diversify and liberalize economies, most EM governments used the boom to maintain the status quo. Now they are tasked with stimulating their markedly non-diverse economies with few tools to work with. Devaluing currencies to stimulate an economy might not be that effective if many of your peers are doing the same. Cutting commodities production might not help if other economies do not do the same.
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