Volatility has always been the defining characteristic of oil and other commodity markets, defying repeated attempts to stabilise prices. Volatility is present at all timescales from seconds, minutes and hours to days, weeks, months and years.
At the macro-scale, the oil market has been characterised since its inception in the 1860s by a series of booms and busts lasting for years at a time.
Efforts to tame the boom-bust cycle through the control of prices and production have repeatedly broken down.
Volatility appears to be an intrinsic quality of oil markets rather than an incidental problem to be solved through improved forecasting, management and coordination.
Traditional explanations for volatility focus on the low price-elasticity of supply and demand as well as long delays in investment and the backward-looking nature of price expectations.
But the concept of feedback loops borrowed from control engineering as well as the theory of complex systems can also help explain some of the endemic instability in the industry.
“There is always too much or too little oil,” economist Paul Frankel complained seven decades ago.
The industry has “an inherent tendency to extreme crises” because production and consumption are not “self-adjusting”.
Frankel blamed the lack of smooth adjustment on the limited responsiveness of supply and demand to moderate changes in prices, at least in the short run.
The result is “a price structure that allows for ups and downs which fail to bring relief from dearth or glut”, Frankel wrote.
The industry is subject to “continuous crises” in which “hectic prosperity is followed all too swiftly by complete collapse”.
Frankel’s words, published just after the end of World War Two, are a perfect description of the subsequent boom and bust in oil during the 1970s and early 1980s, and again between 2004 and 2016.
Frankel argued the only hope for stability lay in the role of the major international oil companies, singly or in combination, as well as governments, acting as “eveners”, “organisers” and “adjusters”.
Frankel was writing before the creation in 1960 of the Organisation of the Petroleum Exporting Countries, which was explicitly committed to stabilising the market.
Opec’s founding statute committed the organisation to stabilising international oil prices with a view to “eliminating harmful and unnecessary fluctuations”.
But Opec has been no more successful at ending the boom-bust cycle than previous stabilisation arrangements operated by the Texas Railroad Commission, the Seven Sisters, the Achnacarry Agreement and Standard Oil.
Frankel blamed the boom-bust cycle on the low price-elasticity of supply and demand, which was in turn due to the fundamental characteristics of production and consumption.
The riskiness and uncertainty of oil exploration; high proportion of fixed costs in refining, transport and marketing; and lack of readily available substitutes for petroleum fuels and lubricants, all contributed to the unresponsiveness of production and consumption to moderate price changes.
Economists have also developed “cobweb theorems” which blame unstable prices on backward-looking price expectations coupled with delays in adjusting production. Price expectations indeed appear to be strongly backward-looking in the oil industry.
In the first few years of the 21st century, painful memories of the long period of low prices in the 1990s held back plans to expand production even as prices surged.
More recently, the production and investment plans of the major oil companies and US shale drillers appear to have been based on the assumption the period of ultra-high prices experienced between 2011 and 2014 would be sustained forever.
When prices have been high for some time, it becomes an entrenched assumption that high prices will persist for the foreseeable future, and vice versa.
At the same time, changes in investment and production take a long while.
It can take a decade or more to train an experienced driller or seismologist, and at least that long to bring many complex offshore oilfields into production.
Oil markets are usually analysed with the language and concepts of economics but they also share many of the characteristics of complex systems.


* John Kemp is a columnist for Reuters. The views expressed are his own.