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Sunday, March 27, 2005

Hockey Stick Graph for Oil

Today's WSJ article by Peter A. McKay called "It's Getting Tough to Find an Energy Boost" once again showed plots of oil prices adjusted for inflation over the past 35 years. You can find an almost identical graph here. The main gist that usually gets conveyed (and annoys me to no end) relates to how oil prices have remained constant when adjusted for inflation. In other words, we don't have it so bad. The qualifier "adjusted for inflation" becomes the standard disclaimer.

My own standard disclaimer goes: economics is the dismal science. I conjecture that these numbers should not, in general, get corrected for inflation. As a thought experiment, instead of looking at oil prices adjusted for inflation of the dollar, look at oil prices in the context of a different currency, namely that of oil itself. That may seem strange at first glance, but as time goes on, oil itself may gradually replace all other artificial forms of currency. In that case, plotting oil adjusted for dollar inflation would seem as foolish as plotting the value of the dollar in terms of dollars -- adjusted for inflation. In elementary (non-Ponzi) logic we call that a tautology.

In other words, scarcity of oil itself leads to inflationary pressures on the dollar. And at some point, and especially if we hit a wave of inflation or stagflation in the coming months, we will have to stop plotting these bloody graphs as "adjusted for inflation". Basically, we need to start facing facts instead of massaging numbers.

As an outcome of reverting to a reality-based perspective, we can start looking at trends afresh. For example, what happens if we track only non-inflation-adjusted oil prices over time. In my own interpretation, it essentially matches that of the "hockey stick graph" well-known in global warming prediction circles. By matching that type of graph, I mean that we can begin to use the same statistical methods to discern trends that climatologists have used over the last few decades. This includes filtering out noise, etc.

When we do hit the knee in the hockey stick for oil, as many people think we have for average global temperatures, we can start to track the inexorable rise in cost. Unfortunately, like global warming, it won't stop until we put into place a real course correction.


Professor Blogger Heading out said...

Unfortunately the differences between supply, demand and peak oil production seem all likely to hit the ventilator sometime later this summer.

I just commented on this atThe Oil Drum in a bit more detail.

8:31 PM  
Professor Blogger SW said...

Well, the interesting thing about this is that I don't really disagree. We aren't paying too much for oil now. That is because as long as you are on the left hand side of the curve there is plenty of the stuff.

I guess that is what fools lots of folks. There is plenty of it, until there isn't. If you have a short enough time horizon it looks like a steadily increasing function. As you get closer to the peak you have to decrease your time horizon to maintain the illusion. I have opted out of that game for now and prefer to pull back and look at the bigger picture. Five years from now there will be no debate. This allows one to watch current events with a degree of humor.

5:35 PM  
Professor Blogger WHT said...

Added to the blog roll.

5:54 PM  
Professor Anonymous Anonymous said...

I agree,

I love NHL. and recently I have bought stock in it. Not like real stock on Wall street, but a stock market that is strictly for sports.

You have seen it? Its pretty cool. You buy issues for your favorite teams and you make real money. Not like a fake stock simulator. I cash out Dividends each time the team wins. Also I can sell my team stock when the price goes up.

check it out if something like this interests you.
heres a link http://allsportsmarket.com
you can log in and check it out for free..

They just released IPO'S for NHL this week, so there are alot of good deals there.

Keep up the good work on your blog!

1:35 PM  

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