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Why the Hysteria Over Oil Prices Is Overblown

01/22/2015 05:09 EST | Updated 03/24/2015 05:59 EDT
Vlad Kochelaevskiy via Getty Images

Wild stormy weather stops us in our tracks. Factories close. Offices are abandoned. School is cancelled. After the rush to stock up, stores are shuttered. And when the storm hits, it's all we can think about -- especially if the power goes out.

It can seem like an eternity, and can obliterate any pre-storm memory. This sounds eerily similar to the oil price tempest we are in the middle of right now. Today's price seems like the only reality, except that the plunge is still on. Are we going to survive this thing? Can we ever expect a return to calm?

Dial in to the news, and you'd be tempted to think not. It's natural that storms bring about their own brand of myopia, but that's when experience should make us wiser. And we all have a lot of that to draw on. We only have to rewind back to 2008 to see a very similar situation to today's. Back then, oil prices slid from well over $100 per barrel at the peak to $40 at the trough, all in about five months. Currently, prices are tumbling from just over $100 to just over $40 over a six-month span. Just eyeballing the raw data, the similarity is staggering. So are other key features.

Both episodes were preceded by positive predictions. Back in 2008, fears that we were running out of oil led to very believable predictions of imminent $200 per barrel crude. Supply constraints in the 1970s led to very similar longer-term predictions. In today's case, predictions weren't as wild, but in general forecasters preferred to believe that a return to global growth would keep prices in the triple-digit zone. Funny how diametrically wrong pundits can be, even with a wealth of instructive recent experience.

Both episodes also produced pessimistic predictions. Ah, the clarity of the ex-post pundit: the 20-20 vision of events repeatedly re-creates the illusion of equally crystal forward vision. Credible forecasters now see $40 oil persisting -- just like they did in 2008, only to watch prices zoom up to $75. Or like the famous call a decade sooner than the last crash -- momentary $10 oil led to a famous and widely-quoted declaration that structural factors were driving prices to $5 per barrel. Over-reactive predictions are probably the most predictable part of large swings in indicators.

Another feature is the "permanent" cancellation of projects. They are gobbling up press lineage as we speak, inciting fears of recession and fiscal red ink. Same thing following 2008. And without a doubt, they have immediate and damaging implications for the economy. But are they permanent? Not unless the plunge actually persists. Subsequent price revival -- even if only partial -- usually gets deal-makers back around the table. The carnage is rarely as bad as feared in mid-storm.

So much for similarities. Are there contrasts? A key difference between 2008 and now is that back then, the biggest recession since the Great Depression was underway. Currently there are worries about weakness, but the US economy is growing gangbusters. Also, back then the economy was highly dependent on policy measures. This time, growth is more than self-generating. One more point: back then supplies were very tight, then not. Now, we believe we are swimming in extra supply, and we seem to have forgotten that today's surpluses could easily be soaked up by resurgent emerging market growth.

What does history tell us? There are moments where sharp movements persisted. The price hikes of the 1970s were with us a long time. The mid-1980s plunge, credited with ending Communism, was around until early in the New Millennium. But those movements were driven by specific structural factors.

Today's plunge, influenced by recent supply, demand and financial liquidity developments, is likely overdone; high-frequency hysteresis-hysteria for the moment seems to be ruling the day. And perhaps the most important, yet oft-forgotten instructive adage on current market mayhem is that in the majority of cases, wild price movements set up the conditions that architect their own undoing.

The bottom line? It's hard to get a grip on reality in the middle of a storm. History tells us plainly that better weather is on the way. But in the clutches of its momentary eternity, the storm convinces us that nothing else matters. Oil's recent rout is likely little different. If so, this too could be a fast-forgotten moment.