Saturday, November 1, 2008
Speaking of Tail Risks
What are the odds of an "unknown unknown" event pushing the price oil up a lot higher or lower? If Bush decides to take down Iran before the new administration moves in, terrorists attack any number of oil bottlenecks, Venezuela or Russia or Nigeria implode, Central Asian pipelines get hit, Iran uses asymmetrical warfare in the Persian Gulf, or, alternatively, large economies shut down, Iraq decides to start pumping out a lot of oil. Production-wise, on one hand you have large oil fields rapidly reaching the peak of their capacities, while the oil spike really sparked a lot of marginal producers to start projects. I can see the short-term shocks going in either direction, and I could see the long-term price of oil moving lower (more substitutes, more production from marginal suppliers) or higher (fall in price of oil kills of new investments, so ageing fields don't get replaced). To me, that suggests high price volatility of oil in either direction is a real possibility. So go out and buy some out of the money derivatives?