Sunday, April 15, 2012

Why ‘trendologists’ are so often wrong

We all have read the brilliant essays about why gold has no choice but to outperform all other investments; why oil prices will peak at $250 per barrel within 18 months; why the economy is going into depression based on demographics and presidential election cycles.  The authors of these works, trendologists I call them, are bright people; specialists in their field of expertise whether that is 'world oil and gas markets' or 'demography'.

So why are those forecasts often so far off the mark? The answer is simple: ‘unforeseen factors’.  That is not entirely true; these unforeseen factors that often create havoc with the most brilliant forecasts would have been obvious to specialists in other fields or a person with a wider view than the trendologist. A good example is Jeff Rubin’s conclusion that high oil prices were the real cause to the 2008-2009 economic slump.  Yes, high oil prices are a bit like interest rates; interest rates influence the availability of credit, a key ingredient for economic growth, and oil prices determine the availability of cheap energy another key ingredient for economic growth. However, the important thing to understand is that there is more than one key ingredient and there are certainly many lesser ingredients that affect the economic stew.
In fact it goes back to a famous quote by a very unpopular politician. It is about the ‘unknown unknowns’ – not necessarily unknown to everyone but likely an ‘unknown’ to the trendologist. Right now, natural gas pricing is defying the logic of many trendologists. On this blog we often quote the rig-count-versus-gas-supply study by Chesapeake to help develop an idea about future gas pricing. But not many trendologists took into account the effect of Natural Gas Liquids pricing, the effects of production hedging, or of Pugh Clauses. Yet, these issues are an intricate part of the oil and gas industry that many trendologists should be aware off.
Not to mention the effects of natural gas being a land locked commodity until pipeline issues such as Keystone, Kitimat and Northern Gateway have been addressed. Issues that are not only governed by economic laws and common sense; they also are governed by politics, in particular by reactionary environmentalists. That latter term may sound inflammatory and the oil and gas industry is not innocent either. In its pursuit of profits this industry does not often accept accountability for its tendency of making shortcuts or for the unintended consequences of its actions that are often affecting social and environmental conditions. But neither are numerous other industrial and economic sectors.

I use this inflammatory language more to point out the aggressive confrontational and often irrational and ideological tendency of the environmental action groups. Some, like the Suzuki Foundation started out with laudatory ideals, but just like the trendologists, they are too focused on a small part of the overall picture. The Suzuki Foundation, in my opinion, evolved from a benevolent organization to an embittered group of reactionary ideologists frustrated at not reaching the narrow objectives they so anxiously cling to.
But I digress…  Oil and gas trendologists failed to recognize along with industry leaders, the importance of being landlocked. Also, the political environment is not very accommodative to break this land-locked situation and this ultimately affects everyone’s economic and general prosperity. The trickledown effect can be especially felt in Alberta, B.C. and Saskatchewan. Strangely enough Quebec also is affected; it almost predictably put the brakes on its shale gas potential.  But this won’t last; sooner or later the land locked dam will burst, the overall economy will grow and with it gas demand, the conversion from coal and oil to cleaner and cheap natural gas will happen and so on and so on. This happens while the economics will prevent the petroleum industry from drilling new gas wells. Oh… and one anomalous warm winter does not spell the end of the heating and cooling seasons in North America with its expanding population base.  So, gas pricing will turn the corner, the question is “When” not “If” – unless there will another ‘unknown unknown’ arise in this tangled story, e.g. a new energy source or a paradigm shift in solar or geothermal energy technology.
We cannot really time when this pricing turn-around will occur. Market timing is a money losing game. We may not be in a position to predict which companies will in the end survive and we may wait a long time before we actually could cash in on an investment in natural gas. But we can start with a small position and gradually, while the picture becomes clearer over time, build a position in this market sector. When all lights are about to turn on green, the buying opportunity has likely passed and everyone plus the kitchen sink will jump in and drive prices up. We want to be ready and fully invested when we reach that point. Investing in natural gas now may make your neighbors declare you ‘insane’ but when the lights turn green one after the other; those same neighbors will jealously declare you lucky!
Trendologists are right, up to a point. Their predictions may point in the right direction but the way you travel may lead you to an entirely different destination that neither the trendologist nor you foresaw. Those who take action will benefit; those who don’t have nothing to benefit from; they just sit on the sideline wondering why they’re not moving ahead.

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