Speaking Of Oil

Since it's impossible to be a good investor without understanding the law of supply and demand, I decided to dedicate the previous week of my Investments class to that topic. After learning the fundamentals of how supply and demand work in the marketplace, I illustrated some real-world examples of this law in action.

First, we talked out the housing market. We also discussed the future of health care with an aging population. We talked about sales of SUVs and Toyota Priuses. Then, we talked about oil

The trend of rising oil prices in the last couple of years and the recent decrease in oil prices can both be explained by the law of supply and demand. First, the class participated in an auction to demonstrate this concept. Some of the students represented oil companies and others represented oil buyers. The buyers and sellers in the classroom negotiated a price, just like what really happens in the oil market. Students came away with the understanding that oil prices are set by market forces, not oil companies alone.

I asked the class if they thought oil would ever hit $6.00 a gallon. They all said yes. I broke the students up into small groups and had them discuss the following question: "What effect would $6.00 a gallon gasoline have on: farmers, grocery stores, families, public schools, transportation companies, and your own investment portfolio." They predicted that the economy would generally slow down if gasoline ever reached that point.

After that, I launched into an explanation of what's been happening with the supply and demand for oil lately. Every student in the class was hooked. I've never seen a class so attentive during a lecture before. They were genuinely interested in this.

I showed charts of US oil production and of global oil production. Oil production in the US peaked in the 1970s and has been in steady decline ever since. Global oil production has generally risen at a rate of 2% per year, but it has remained generally flat in the last two years. We discussed the fact that oil is not an infinite resource, and that eventually, global oil production will start a steady and irreversible decline just as it has in the US. I mentioned that no one knows for sure when that will happen, but I did show the class a chart from the US Energy Information Administration that predicts this peak at around 2037.

The next thing we did was talked about ways we could either increase the supply or reduce the demand for oil. They mentioned drilling in Alaska, carpooling, drilling offshore, and using alternative energy sources. We briefly mentioned the pros and cons of some of the possible solutions. Again, the students were very engaged.

I presented this lesson as objectively as I possibly could. I avoided making any claims or predictions about the future. I ended the class on a positive note, talking about some of the good things that are being done in alternative energy, and talking about solutions instead of focusing on the problem. Still, the mood in the classroom was pretty somber that day. I knew that I had to be careful about presenting this topic for a variety of reasons. Peak oil is still a controversial and political topic.

When I got home, I started questioning whether I should have even brought up the subject. This information really seemed to have an effect on the students, and I was a little concerned about some of the parents' reactions. I've had a few days to contemplate this, and I think my decision to have an honest discussion about oil was a good one. Students need to know about this issue, because it will have a direct impact on them. The topic absolutely belongs in an investments class, because it has a direct impact on investment portfolios. The news about the supply and demand of oil may have been a bit depressing to some of the students, but I'd rather have them know about it than just pretend that the problem doesn't exist. Most Americans don’t have any understanding whatsoever of energy markets, and people should be educated about them.

Don't Write Tests When You're Tired
I put a really bad question on the test for this unit:

"The US continues to demand more oil from the middle east, but these countries are unable to pump oil out of the ground any faster. What will happen to oil prices?"

I wrote this question the day before the test. I was tired and in a hurry. The question is flawed on several levels. Both of the assertions are incorrect. US demand for oil has decreased in recent months, not increased. Also, it's not true that middle east countries are unable to increase their production levels. Oil production actually went up slightly in 2008. The biggest flaw is that the question assumes that the only factors influencing global oil prices are US demand and middle east supply. That's just plain wrong. There are more producers and consumers of oil than just the US and middle east. The global price of oil reflects market players all over the world, not just in these two regions.

So, this test is giving students misinformation. Most students will come away with the idea that US demand will always rise, middle east supplies will never rise, and that oil prices will always rise (this is technically the "correct" answer to the question). None of those things are necessarily true. So I guess the moral of the story is: never write tests when you're tired.