An inconvenient guess

An excellent article from Bloomberg on one reason behind the Amaranth debacle, which lost $6.5 billion in asset value as energy prices tanked. Many of the markets were focusing on forecasts that predicted a rough hurricane season in the Atlantic that, it true, would impact oil and gas production again this year.

Why did traders believe these forecasts when they probably don’t believe their local weatherman? Mostly because the same forecast was made by experts at Colorado State University, who have a decent track record on predicting upcoming hurricane activity.

Last week, one of the most closely watched forecasters, Colorado State University, said that it had overstated the hurricane risk. The bungled forecasts shed light on what happens when energy traders, investors and, in some cases, the news media rely too heavily on an inexact science.

I have trouble with the word “bungled” in that quote. It was a forecast. Results didn’t come in as planned. But that doesn’t mean the forecast was bungled—espcially if the forecast was made with the best information available and using the same methodology that produced impressive results as in the past. The key word is forecast. A forecast is crystal-ball gazing, and becomes more or less reliable with the forecasters credentials, methodology, etc. But it still remains a forecast, not reality.

Forecasts come in many shapes and forms, from published reports to betting lines. And while they may be accurate at times, they don’t always reflect what will happen. That’s why they still played the Auburn-Arkansas football game this past weekend, even though Auburn was heavily favored.

But there is much more riding on long-term weather forecasts. Public policy and production standards are being driven by a lot of junk science, with environmental shibboleths substituted for critical thinking and verifiable relationships. Amaranth Advisors bet the farm on such an inconvenient guess and paid the price.