Elliot Wave's Futures Focus: Getting a Grip on Slippery Logic About Oil

Getting a Grip on Slippery Logic About Oil
10/1/2004 5:30:09 PM

Every day this week, headlines have explained the rise in Crude Oil prices with cause-and-effect logic that only seems plausible. Here's one from today:

Supply Worries Lift Oil Near $50 US (Toronto Star , October 1)

If this sounds right to you, it's probably because you've heard similar stories over and over. The fact is, explanations like this one are misleading, even if they do jibe with conventional wisdom. So what's the best alternative? Try turning this headline around:

Oil Near $50 US Lifts Supply Worries

Just by flipping a few words, the explanation changes completely… for the better. The prevailing perceptions about supply and demand tightness don't cause Crude Oil prices to surge. Rather, fluctuations in the price of Crude actually cause perceptions about Oil supplies to change.

Recent energy news provides more evidence of faulty logic. Citing supply disruptions due to weather, two oil companies solicited and received loans from the U.S. Strategic Petroleum Reserve (SPR) last week. Depending on what a barrel of Crude cost when the papers went to press, journalists reported the same fundamental "cause" as having two opposite effects.

When prices sagged on September 24, many headlines looked like this one:

Oil Dips as U.S. Loans Out Supplies (CNNMoney/Reuters )

But because Crude Oil finished higher that day and opened this week higher still, the news on September 27 offered a starkly different perception of SPR interventions. Here's an example:

"If anything, the market has taken the SPR loan as a bullish factor as it highlights how tight the market is in the U.S. Gulf, brokers said." ( Wall Street Journal Online)

These two stories contradict each other for a simple, yet striking reason: fundamentals like supply concerns don't drive prices, prices drive fundamentals. The news itself reflects what's already happened in the market -- in other words, it is a lagging indicator.