Mr. Market, manic-depressive: Is there a cure?

…For society as a whole, however, the manic-depressive nature of markets can have serious and even potentially dangerous consequences. Wild price swings make it difficult for people, companies and governments to plan. It is just such behavior which has characterized the energy markets in recent years. And, there are reasons to believe that we should expect more of the same.

First, queuing theory (essentially, the theory of how lines form) tells us that when a system approaches 100 percent of its capacity, the length of the line to access that system can become highly chaotic, changing from very short to very long in rapid succession. In our case the line is filled by those trying to buy energy, particularly natural gas, oil and coal. (I am indebted to Kenneth Deffeyes for pointing out the relationship between queuing theory and energy prices in his book, Beyond Oil.)

In North America the natural gas system has been operating near capacity for several years. Only warm weather has prevented a serious crisis. For all intents and purposes, North American natural gas supplies have peaked and have been on a long plateau. When Hurricane Katrina hit in 2005, the line of those eager to nail down natural gas deliveries for the coming winter became very long, very quickly. But that line dissipated just as quickly when the winter turned out to be one of the warmest in history. As a result the price of natural gas first rose to almost $15 per thousand cubic feet and then dropped below $5 before rebounding.

Meanwhile, in the oil markets turmoil in the Middle East and fears of hurricanes in the Gulf of Mexico took prices to near $80 a barrel last summer. The price hikes were not merely the result of fear, but also the result of very little spare capacity for producing oil around the world. When those fears subsided, the number of people in line to buy oil suddenly dropped as did the price. This is exactly what queuing theory would predict in an oil market running near capacity. Whether the capacity problem is permanent because we’ve hit world peak oil production or merely temporary is unknown. But the result for now is wildly swinging oil prices.

Energy Bulletin