Why the Futures Markets Overreact to Current Events

Justin Christensen |

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Whether we like to admit it or not, we are emotional beings. As a matter of fact, a number of studies have confirmed that up to 90% of our decisions are based on emotions.

So, what does this have to do with the Futures Markets?

Oil prices are influenced by a number of factors, including supply and demand, geopolitics, weather, natural disasters and refinery activity.

At the heart of energy markets are people – consumers, investors, producers, suppliers and traders. This means the markets will also be influenced by emotions such as fear, greed, confidence and anxiety, as well as the impossibility of predicting the future.

Shock and Uncertainty

Any time an event that might affect the industry occurs, whether it’s positive or negative, planned or unplanned, the market overreacts. An initial reaction of shock, for example, will see prices jump. They will also jump at uncertainty. Nervousness about the unknown leads to planning for the worst-case scenario.

Hurricane Katrina in August 2005 and 9/11 are major examples. In the first case, unleaded gasoline futures traded at a record high of $2.68 a gallon and consumers were paying as much as $3 a gallon. In the latter, prices also jumped and retailer price gouging saw some charging as much as $8 a gallon.

When a situation starts to settle down or the extent of it becomes clearer, prices will level out as the effect on oil production becomes more apparent. Other times, the event itself may reverse a price hike, such as the global recession in 2008-2009, where the focus is more about survival than growth.

Invisible Borders

We don’t have to be at the center of the action to have an emotional response or be impacted by an event. A prime example is Russia’s annexation of the Crimea from Ukraine in March. The reasons as to why it happened are rooted in history and tied to military strategy, as well as economics and the region’s natural resources.

However, the ramifications are felt internationally – Russia is the world’s leading oil producer, Ukraine’s pipelines feed natural gas from Russia to Europe, and Exxon Mobil had plans to erect two deepwater wells for $735 million in the Black Sea.

With fears of a supply disruption looming, oil prices here at home surged to a 5-month high at $105 a barrel. In the last month, the situation has calmed, so crude prices have dropped $5 a barrel and products are 10 to 13 cents less.

Other Factors

Oil prices are not limited to emotional responses on their own. Stock market analysts indicate psychological opposition and support levels favor even or round numbers. As prices rose in 2007-2008, some believe the apprehension and excitement of breaking the $100/bbl price point may have influenced the increase.

Bold forecasts can also contribute to price changes. When companies such as multinational investment banking firm, Goldman Sachs, OPEC and Gazprom or big oil tycoons such as T. Boone Pickens start making predictions based on current events, the ripple effect can cause fear and uncertainty in the markets as well. Their credibility has many traders buying based on their reports alone.

Why don’t prices stay the same until the extent of an event becomes clear? It’s a way for the market to mitigate the impact. Balancing prices and supply with demand is a form of protection for everyone until situations return to normal.

You can count on your fuel distributor, with their expertise and experience, to help you make sense of the market and offer products and services to meet all of your business needs. It’s one decision about which you should have no uncertainty.