Oil prices have been cut in half in the last six months. Petrol prices in the U.S. are now lower than they were a decade ago. Almost half of U.S. petrol stations sold petrol for less than two bucks a gallon last week. Who should American drivers thank for this savings? The most popular explanation is the fracking boom, which has doubled U.S. oil production since 2005. “Drivers paying less at the pump due to free-falling oil prices can thank the U.S. energy boom for generating shale oil,” wrote Fox News last week. “Thank Fracking For Falling Gas Prices,” wrote The…
Oil prices have been cut in half in the last six months. Petrol prices in the U.S. are now lower than they were a decade ago. Almost half of U.S. petrol stations sold petrol for less than two bucks a gallon last week.
Who should American drivers thank for this savings?
The most popular explanation is the fracking boom, which has doubled U.S. oil production since 2005.
“Drivers paying less at the pump due to free-falling oil prices can thank the U.S. energy boom for generating shale oil,” wrote Fox News last week.
“Thank Fracking For Falling Gas Prices,” wrote The Daily Caller.
They’re probably right. It seems so obvious that the U.S. oil boom is pushing down gas prices that few feel much need to explain it any further.
But there’s something funny here.
We’ve known about the U.S. energy boom for years, long before oil prices started falling. And it wasn’t long ago that most people argued the U.S. oil boom would not lower gas prices.
“‘Drill, Baby, Drill’ Fails: Why Gasoline Prices Remain High Despite Oil Boom,” stated one article in 2013.
“Why More U.S. Oil May Not Mean Cheaper U.S. Gas,” argued another.
Before June, it was widely reasoned that since oil was traded on global markets, and demand from growing economies like China was ramping up, the U.S. oil boom wouldn’t lead to lower gas prices.
These arguments made sense, and were reasonable at the time.
But today we’re making the exact opposite argument. And just as confidently as before.
Why is it so easy to breathlessly claim that falling oil prices are obviously due to the U.S. energy boom – as if we knew that all along – when so many people made the opposite argument six months ago?
Things change, and forecasting is hard. Global demand for oil slowed, and OPEC hasn’t cut production. Few foresaw those developments, and they’ve helped pushed down oil prices.
But there’s also some hindsight bias going on here.
Hindsight bias is the ability to think you’ve believed something all along – like the U.S. oil boom pushing down petrol prices – when in reality you thought something different in the past. It’s also called the “I Knew It All Along” fallacy.
In his book Thinking, Fast and Slow, psychologist Daniel Kahneman writes:
“A general limitation of the human mind is its imperfect ability to reconstruct past states of knowledge, or beliefs that have changed. Once you adopt a new view of the world (or of any part of it), you immediately lose much of your ability to recall what you used to believe before your mind changed.”
It seems so obvious today that doubling U.S. oil production would clobber oil prices. But it’s difficult to remember how few people actually believed that to be the case just six months ago.
Hindsight bias clouds our thinking, giving the impression that the world works in clean, predictable ways that fit into a logical narrative, when in reality we’re being fooled left and right, more comfortable changing the script than admitting that things are complicated and unpredictable.
It’s powerful stuff.
Before Richard Nixon went to China in 1972, psychologist Baruch Fischhoff asked a group of students to estimate the probabilities of certain outcomes of the historic trip, like whether the U.S. would grant China diplomatic recognition, or whether Mao Zedong would even meet with the president.
After the trip, Fischhoff asked the students to recall the probabilities they gave. He showed that if an event actually occurred, the students believed they had given it a higher probability of occurring before the trip. If an event didn’t occur, the students remembered giving it a lower probability of occurring than they actually did.
Another group of psychologists asked people what the odds were that O.J. Simpson would be found guilty of murder two hours before his verdict, and then followed up 48 hours after he was acquitted.
“People were much more likely to judge that Simpson would be acquitted in the post-verdict sessions (and hence after they knew that he had been acquitted) than before they knew the verdict in the case,” they wrote.
We did this during the financial crisis in 2008. It seems so obvious that housing was a bubble in 2006 and that the banking system would crumble when the bill came due. Everyone realizes it in hindsight. But a pretty common view before 2007 was that, even if housing was a bubble, its unwinding would be contained to subprime mortgages. Most who were later heralded for predicting the financial crisis were right for the wrong reason – they foresaw a collapsing dollar and rising interest rates sparking the financial crisis, which is the opposite of what actually occurred.
Who knows what will happen to oil prices. But whatever does happen, don’t pretend like you knew it all along.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. This article was written by Morgan Housel and first published on fool.com. It has been edited for fool.sg.