Is $10 Oil on The Horizon?

Mar 19, 2020 | Oil

According to a number of cognitive scientists, mankind uses its unique ability to reason primarily for justifying pre-held convictions, rather than for forming convictions. It is of critical importance for strategists to understand and acknowledge this human tendency, as it causes one to easily fall prey to a number of cognitive biases, which prevent one from seeing things how they really are, and more important for the strategist, how they are likely to become.

One of the most famous cognitive biases is confirmation bias. As we prefer to be proven correct, we naturally incline towards information that confirms our views and try to ignore or reason away information that does not.

This tendency was on full display before, during and after the 2008 Global Financial Crisis. At that time most analysts were continuously behind the facts, consequently underestimating what would happen next, because reality went against ideas and conviction that had become loved in the financial community, such as the perfect market theory and the idea that through derivates risks could be managed away.

For most financial strategists, it was simply too painful for many to acknowledge these ideas were incorrect (or at a minimum: contained serious flaws), even though the evidence was there, which would eventually lead Queen Elizabeth to ask them “Why did no one see this coming?”. Of course, not everyone didn’t see it coming. Those who were able to manage their confirmation bias either made a lot of money or became famous…

Now that the world is battling another unprecedented crisis in the coronavirus, the biggest risk for energy strategists is to fall prey to cognitive biases, in which case their forecasts would be about what they would like to see happen, rather than about what is likely to happen. This article is an attempt at forecasting the impact the coronavirus will have on crude oil demand while avoiding such biases.

The Current Situation

First reports of the coronavirus came from China. The first person known to have fallen ill due to the virus was in Wuhan, on 1 December 2019. By the end of that month, the Chinese government realized it was dealing with an epidemic. On 23 January 2020, it implemented its first measures to bring the epidemic under control, which was a quarantine of the affected area. Ever since additional steps have been taken to fight the virus, such as prohibiting large public gatherings, closing schools and universities, and severely restricting travel.

by Andreas de Vries

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