Expectations and Markets: A Case Study in Oil

Lynne Kiesling

I was just saying to a couple of colleagues yesterday that one of the things we take almost as axiomatic in economics-that prices are a function of expectations of future supply and demand-is little understood by laypeople. Oil markets recently have provided a good example of that interaction.

Take, for example, this Bloomberg article from Monday, noting that

Crude oil fell for a sixth day, its longest losing streak in almost three years, on signs that fuel demand growth will slow with the global economy and ample stockpiles in the U.S., consumer of a quarter of the world’s oil.

The price has been moving based on expectations of future demand falling relative to expectations of future supply. I find this all fascinating, because oil markets get, and internalize and respond to, a barrage of information that will affect both demand and supply tomorrow, a year hence, five years from now, and everything in between. These factors range from fundamentals like changing consumption and production technology and discoveries of new resources (such as the deep Gulf deposit last week) to political risk to weather. When I think analytically about all of the variety and timeframes of information that oil markets process, my respect and admiration grows for what futures markets accomplish.

Then this morning I find two additional articles, the first being this one on Saudi investment plans and an IEA report on slowing demand:

Crude oil traded near a five-month low as Middle East producers said they will invest as much as $94 billion on oil and gas infrastructure and the International Energy Agency lowered global demand estimates.

These new pieces of information in the media did not move prices very much this morning. My surmise is that traders already knew these two facts, and that they have been incorporated into price movements over the past five days. That’s why sometimes information like this is unexpectedly anticlimactic; actual market participants have already incorporated it into their choices.

Then a third story suggests that oil prices in Europe rose late this afternoon amid the possibility of increased political risk after the foiled US Embassy bombing in Damascus. Prices as of the story’s filing had risen slightly, only 1.3 percent. Again, this shows how much of the expectation of future effects have been priced in already.


One thought on “Expectations and Markets: A Case Study in Oil

  1. Besides expectations, I think, one should always consider that prices are set by current actual supply and demand for every individual security, in this case oil futures (or spot prices).

    Expectations, of course do influence the current decisions of the investors (speculators) and as long as they are priced in, the actual news does not provide much impact. Even it occurs often that the reaction of the market is just the opposite to the “news direction� (or the rational meaning of the news for the prices). We speak than of fait accompli.

    What I wanted to point at, is, that the current “technical� situation can even “overwrite� the expectations. If the market is fueled by “paper� (not real oil) it will be driven down. Regardless even of expectations.

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