Thursday, December 10, 2015

Oil: The Dornbusch Effect

(Drivebycuriosity) - "Markets tend to overshoot and to undershoot", said once the late economist Rüdiger Dornbusch (wikipedia). Even that he formulated his claim (model) for foreign exchange rates and the currency market (imf),  the Dornbusch effect is also a good explanation for what is happening on the oil market now.

Most producers can survive with an oil price of about $60 and the long term average oil price hovers around $50 (bloomberg oilprice). But in the period 2010 through 2014 oil cost around $110, twice the average price and way higher than the costs of pumping.

I think that this huge overshooting over such a long term disturbed the balance of the oil market strikingly. Prices high above long term average & production costs encouraged production (especially in the US and dampened demand significantly. Therefore in the period 2010 through 2014  there accumulated a massive oversupply.

I think that oil prices have to undershoot  (falling deep below) average price & production costs significantly to get rid of the oil flood (to clear the market).The hyperbole of the years 2010 through 2014 might create now a hyperbole in the opposite direction.

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