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Are Oil Prices Really Driven By Supply And Demand?

Trading desk

For most people the reflexive answer to the title question is yes. Consider, however, that over various time spans since 1980, the price of oil has dropped 75, 76, 78, and 75 percent, and risen 320, 265, 370, 196, and 254 percent (The Socionomic Theory of Finance, Robert Prechter, page 458). Prices for most goods sold in retail establishments, presumably determined by supply and demand, haven’t swing up and down like that over the years in either nominal or inflation-adjusted terms.

Perhaps oil supply and demand have special characteristics that drive the price in ways such that percentage changes in price are far greater than the underlying percentage changes in production or consumption. If so, does anyone have a model that predicts supply and demand and delineates a relationship between them and the price of oil? Does this model yield testable hypothesis, and what is its predictive record? Has it consistently caught oil’s dramatic price swings?

There is a model that has repeatedly predicted oil’s price swings and the amplitude of the ensuing trend, but explicitly rejects supply and demand as independent variables. At the very least, this model should prompt a critical examination of the supply and demand hypothesis and its applicability to the oil market.

In Robert Prechter’s recently released The Socionomic Theory of Finance (STF), Chapter 22, “Elliott Waves vs. Supply and Demand: The Oil Market,” the author surveys the predictive track record of oil market analysts at his company, Elliott Wave International (EWI). It is superior to any other record of which I am aware.

Stripped to its essentials, here are the basics of the socionomic theory.

The main theoretical principles are that in human, complex systems:

• Shared unconscious impulses to herd in contexts of uncertainty lead to mass psychological dynamics manifested as social mood trends.

• These social mood trends conform to a hierarchal fractal called the Wave Principle (WP) and therefore are probabilistically predictable.

• These patterns of human aggregate behavior are form-determined due to endogenous processes, rather than mechanistically determined by exogenous causes.

• Social mood trends determine the character of social actions and are their underlying cause.

STF, pg. 313

As established by R.N. Elliott empirically and Benoit Mandelbrot mathematically, financial prices fluctuate as a fractal, with a comparable style of movement on all time scales, from seconds to centuries.

STF, pg. 232

A fractal, according to the Merriam-Webster online dictionary, is: “[A]ny of various extremely irregular curves or shapes for which any suitably chosen part is similar in shape to a given larger or smaller part when magnified or reduced to the same size.” Related: Panic In Vienna: OPEC Needs To Bring Down Costs To Compete With U.S. Shale

While Elliott Waves in financial markets are irregular fractals, they take shape according to certain guidelines and mathematical relationships. Social mood trends, regulated by their own internal, or endogenous, dynamics and impervious to external influences (including supply and demand), motivate social actions in contexts of uncertainly, such as financial markets. For any given time period a market can go up or down, but Elliot Wave analysis yields probabilistic predictions about its likely direction and pattern, which means it can be empirically tested.

The heart of Chapter 22 is a history of Prechter and EWI analysts’ calls on the oil market since 1993, when EWI initiated coverage of that market. Contemporaneous charts and excerpts document their calls, which came either just before or just after eight major turning points (the wave after the ninth is in progress so the jury is still out). Plenty of Wall Street seers make good money drawing straight lines, talking about supply and demand, and predicting consolidations, pullbacks, or bounces, but that crowd has invariably been surprised by the oil market’s huge crashes and rallies. Prechter and crew got the turning points right and demonstrated a noteworthy degree of accuracy on the amplitude of the ensuing moves.

The chapter’s comic relief is provided by its references to books, magazine articles, and quotes from “expert” commentators, economists, analysts, and academics whose choruses of supremely confident predictions are repeatedly obliterated by the market (the predictors generally hold on to their jobs). Peak oil theories and to-the-moon price projections are trotted out at market tops, permanent glut theories and gloom-and-doom at market bottoms. The experts are just as caught up in social mood as everybody else. Without knowing a thing about Elliott Waves, speculators who simply kept track of the quantity, tone, and certainty of forecasts and bet the opposite way when they reached extremes would have done quite well.

No forecasting method is perfect. By its own premises the EWT cannot be. Wave labeling on charts is always with the implicit caveat that it is tentative and subject to future revision—the highest probability forecast is not always the correct one. EWI has had its share of “revisions,” aka “whiffs,” across a variety of markets. However, even those who don’t buy into Prechter’s hypotheses, analyses, or methodologies will find his book intellectually valuable. He has shifted the terms of the debate, proposing that financial markets are not black boxes, rationally balancing supply and demand and deriving equilibrium prices; they’re probabilistically predictable exercises in mass psychology. Competing theories must meet the tests of basic science: testable hypothesis and predictive validity greater than that demonstrated by the EWT.

Someone may build a better theoretical and predictive mousetrap. Until then, oil market participants—from second-by-second speculators to industry executives pondering long range strategic decisions—can benefit from Prechter’s unique perspective and theory.

By Robert Gore for Oilprice.com

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  • JACK MA on March 02 2017 said:
    Petrodollar exports turned negative in 2014. This was the first time in 20 years. What happen 20 years ago? Russia abandoned the dollar 20 years ago and so they are doing this now but now they will not collapse like 20 years ago. The is a dollar war not a oil cycle.

    Supply includes 400 million barrels of fake paper oil. At least 800,000 bpd in 2015 alone. The oil is missing meaning no one can find it. It never existed but it is used to drive down prices until sovereign nation defaults put these oil assets in the hands of the elites and into the revenue streams. Kerry wanted Russia to collapse of course and for the BRICS to fail. TPP was all about keeping the world on the dollar and stopping the Silk Road of Eurasia.

    That is where we are now. Only Russia will survive as a oil exporter. Supply and demand numbers are all fake. You see SA cut and cut and cut and prices still drop. This is because Venezuela has not yet defaulted into the hands of the IMF yet. This game goes on and on but once the Elites are in said revenue streams and they have overtaken sovereign governments, they will let oil rise.


    Saudi could stop production all together and oil will still not rise. The long term effect of this paper oil driving prices down is the lack of cap ex for finding future oil and in this moment lies the massive oil shortage on the way in a few years.


    The game is rigged. Does not mean you cannot win though...if you know how the game is rigged. Paper oil and dark oil and ironically during these dollar wars the real level of real oil remains constant, and the future shortage results from ongoing future demand but the lack of cap ex now. This will drive price up when the right be are at the profit collection table.

    Nations can be won without a shot, but of course that is not so good for the military complex so they will feed weapons to the Sunni and Shia in the ME until Mohammad rises from the dead to settle the dispute about his own successor. lol

    food for thinking....hmmm
  • EH on March 02 2017 said:
    That's what our EX-PRESIDENT oil MAN Bush and Cheney wanted us to believe BUT,, NO and DOUBLE NO. It's a Capitalistic system it's called WHATEVER THE MARKET WILL YIELD TO!
  • rjs on March 02 2017 said:
    the daily volume of trading in oil contracts is roughly 100 times the weekly supply & consumption of oil...hence, the traders set the price, and supply & demand have little to do with it...
  • Earl Richards on March 03 2017 said:
    The oil prices are rigged. Google and read, "The $2.5 Trillion Oil Scam - SlideShare".

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