Many readers will know about the claim that a frog plopped into boiling water will hop right back out if it can, while one put into cold water which is then slowly heated will remain until it is cooked. The claim is wrong, but the story is quite useful in understanding some human behavior. Gradually changing circumstances are typically more difficult for humans to detect and react to than circumstances that are changing rapidly.
Such is the case with oil prices. The velocity with which oil prices rose in 2007 and 2008 transfixed the public and policymakers. The price vaulted from $60 a barrel on the first trading day of 2007 to above $147 on July 11, 2008, the (so far) all-time high.
At the time many believed that oil production might be reaching a limit that would never be breached, a possibility with dire implications for a society deriving more than a third of its energy from oil and dependent on the substance as a basis for myriad products such as plastics, pharmaceuticals, herbicides, pesticides, lubricants, heating fuel, fabrics, paints, solvents, and asphalt, just to name a few.
When oil prices then plunged as a result of a crashing economy, no one knew what to expect except those of us who had been following the supply picture carefully. That supply picture suggested rapidly recovering prices as the economy rebounded. As it turned out, the spot price rose from just under $34 per barrel on December 26, 2008 to $126 on April 28, 2011. Again, the spectre of limits hung over the market and the public.
Now, the strange thing is that the worldwide average daily price hit records in both 2011 and 2012 if we go by the Brent price which has come to represent the true world price. And, we may be headed for another record this year. But the rise has been so incremental from $111.26 in 2011 to $111.63 in 2012 that it can hardly be called a rise. Like the proverbial frog in gradually warming water, the public has become used to high oil prices and so doesn't often think about what they imply--namely, continued constrained supply despite all the distracting and misleading histrionics from the industry claiming that we've entered a new era of abundance. Oil's persistently high price is, of course, an embarrassing and decisive indicator that the claim is nonsense.
So far this year, the daily Brent crude price through July 30 has averaged $107.43. Will it rise enough from here to top 2012's average? We cannot know. But the fact that oil prices have remained in or near record territory for two years running no longer elicits alarm from the public, the industry or policymakers. High prices have become the new normal. This is the ever so slightly warming water in which we frog-humans are sitting while no longer noticing the change (or remembering how unnerving it was as prices rose rapidly to this level).
It's worth remembering that the current average price for the year remains well above the average daily price for all of 2008, the year that stunned the world with the highest oil price ever. The 2008 average was only $96.94, again using Brent crude prices as a proxy for world prices.
Like the frog, for us humans it is the velocity of price changes which grabs our attention, not the persistent high price. The reason for the high price is clear. Demand remains robust, especially in Asia, and supply remains constrained. As I pointed out last week, supply has only advanced a paltry 2.7 percent in seven years vs. about a 1.5 percent increase on average EVERY YEAR prior to that (from the early 1990s onward) for crude including lease condensate (which is the proper definition of oil).
We have come to accept high-priced oil, and we will probably accept it until the next crisis causes prices to bolt quickly upward getting our attention again. As Nassim Nicholas Taleb, the former hedge fund manager, self-styled philosopher of risk, and author of The Black Swan tells us, the longer a system appears stable, the greater the disruption will be when stability breaks down.
Oil prices have been on average at their highest ever for the past two years and may reach a record again this year. But they have also essentially been stable because the change in the average daily price has been so slight. Watch out for what comes next after that stability evaporates.
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Source: http://www.resilience.org/stories/2013-08-04/of-boiling-frogs-and-oil-prices
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(Image: Indiana University)
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