Oil markets have fallen precipitously in recent months. Prices are now half of what they were last summer. This stunning price move is akin to throwing a rock into a pond; there are bound to be ripple effects.
But the rapid fall in prices doesn’t call for a hasty response. Oil markets are complex, adaptive systems, with prices that are notoriously difficult to forecast, and there are many divergent paths that prices could take.
Canadians are now facing the oil equivalent of Schrödinger’s cat.
Schrödinger’s cat is a thought experiment in quantum mechanics in which a cat is placed in a box, along with a flask of poison, a Geiger counter and a radioactive source. If the Geiger counter detects radioactivity, the flask shatters, the poison is released and the cat goes to kitty heaven. If the Geiger detects no radioactivity, the cat lives. Yet according to quantum mechanics, without lifting the lid and taking a look inside, the cat is both dead and alive at the same time. This is based on the Copenhagen interpretation of quantum mechanics, which states that a particle exists in all states until observed.
Schrödinger’s cat is a metaphor for the unpredictable: the radioactive particles have either decayed or they haven’t, the cat is either alive or dead, but there is no way to know the outcome until the box is opened.
This is analogous to the current state of oil markets—the outcome is unknown. Many oil producers argue that the recent fall in prices was due to a supply shock—a significant increase in oil production, which forced lower prices. They contend that the marginal oil producers with the highest cost assets will not be able to compete at these levels and will go bankrupt, thereby lowering the total supply of oil and forcing prices to rebound.
Yet this prediction relies on assumptions that may not prove true. If the industry adapts to a lower cost structure, where most players survive and OPEC maintains current levels of production, then it is conceivable that oil prices will stay low for longer than expected. Investors need only look to the North American natural gas market for an example of a long-lasting supply glut. But, just like the fate of Schrödinger’s cat, no one knows for certain how this will all play out.
Thankfully, investors don’t have to predict the future, as resilient portfolios can be built to endure most inclement weather. Investors can develop such resilience by investing in “boring,” wealth-creating companies, run by excellent management teams, that are purchased at an attractive price. They can also ensure adequate diversification in their portfolios by not only looking beyond energy markets, but also outside of Canada, for opportunities.
The paradox of Schrödinger’s cat often manifests in investing—it is frequently impossible to know for certain which outcomes will unfold. Rather than anxiously attempting to predict the future, investors are better off putting the odds in their favour by adopting a systematic, common-sense investment approach. It may be boring, but it works.
- See more at: http://www.mawer.com/knowledge-centre/recent-articles/schroedinger-s-cat-and-the-price-of-oil/#sthash.pNSJwJFT.dpuf
