100 Economics Question of the Day: An Intermittent Blog: Why Did the Price of Oil Rise Today? (30 Aug - 1 Sep)

Tuesday, August 30, 2005

Why Did the Price of Oil Rise Today? (30 Aug - 1 Sep)

This is a markets question, really, not an economics one.

As axioms go, "buy on the rumour, sell on the fact" is still more the rule than the exception in the financial markets. So why would the "fact" being less severe than the rumour result in a price increase?

A casual check of Sunday's blogverse finds a post from Atrios on Sunday night of the then-current forecast for the Louisiana area:
The market certainly knew this before anyone started trading on Monday.

So it was no secret that (1) the LA/Gulf Coast area is a major source of oil, (2) the LA/Gulf Coast area was likely to be in bad shape ("at a standstill") by Tuesday morning.

And, indeed, that is what happened. However, while we should in no way belittle the human and direct economic costs, the damage caused by Katrina was, if anything, less than that expected on Sunday/Monday morning.

So traders knew nothing today that was worse than they expected yesterday. If you expected on Monday that a Category 5 hurricane to hit New Orleans, or much of Biloxi to be "uninhabitable," it would only be natural to expect that oil production in the Gulf would be impacted--severely for a few days, significantly for a while (logistical issue; getting people to and able to work while they try to rebuild their lives and homes), but not for the long term.

Now Tuesday has come around, and New Orleans was hit with a Category 4 (certainly more than bad enough, but not the expected Category 5) hurricane, and nothing else was hit worse than the predictions and expectations of Monday. (Again, the point is not that the predictions in any way ease the suffering and dislocations, just that the result was not worse than the expected horror.)

So why would the price of oil go up over 4.9% ($3.30 from $67.20) today? And what does that say about rational expectations and/or the efficiency of the market?

UPDATE: Apparently, in part because of poor resource allocation and in partthe post-hurricane activities, the damage is every bit as bad as originally expected. Meanwhile (hat tip: Max), James Hamilton has more on the actual damage done to production, including this note that was not highlighted in the CNN story referenced above:
In New York, oil prices sunk from their $70/barrel opening price to end the day at $67.20, up just a little over a dollar a barrel for the day. [emphasis mine]

Otoh, CNBC currently (31 Aug, 11:00am EDT) lists Crude Oil price at $70.05, up $0.24, which implies that yesterday's close was $69.81.

Again, the human tragedy is significantly more important, long-term, than this temporary problem with production/refining. But the market reaction is easier to measure for precisely that reason.

UPDATE 2: Tom Bozzo suggests another scenario. His conclusion--that the rally is a selling opportunity--appears to be the same, though.

UPDATE 3: How Risk Management in the face of very solid, very public information should have been done.

[A] brigade of the 101st would be have moved to Ft. Polk over the weekend and their helicopters would have been rescuing people as soon as the weathered cleared. Their heavy lift battalion would have been ferrying in supplies to isolated communities and the AF would have been dropping humanitarian aid packages like they did in Afghanistan over isolated rural areas. But that would be a serious understanding of the situation.

The upfront cost might have been substantial, but it will be far less than the incremental FEMA and insurance costs. The only point of disagreement is that this didn't take Mr. Bush understanding the situation--almost anyone in the administration, from Michael Chertoff to Secretary of the Interior Gale Norton (whose organization is conspicuous in its absence from this press release) to the Undersecretary for Emergency Preparedness and Response [emphasis mine] could have made this a less dangerous, less expensive, and less of the disaster it is.


Blogger Tom Bozzo said...

Damn comment spam (above).

My updated view is that the differential effects (if not the specific magnitudes) on the oil and gasoline markets make some sense with the fundamentals -- I followed a link from one of Hamilton's posts to an Oil Drum item confirming a quick mental calculation I'd run on the severity of the refinery disruption and the attendant prospects for gasoline supply failures.

But I'm not paid to follow the timing details in those markets, so this is not apropos of anything specific with respect to your main conundrum question.

01 September, 2005 12:28  

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