"We're running out of oil!!!"

It's a common refrain at the dinner table of any partially informed amateur economist. The problem is that it's true. Oil, as we all know, is not an infinite resource like, say, sunlight. It is an irrefutable fact that there is a magic number that represents the true volume of every drop of liquid oil on the planet.

Unfortunately for armchair economists, even if you knew that number, it wouldn't do you much good.

Oil prices (whether the actual barrel on a dock, the spot market, or a NYMEX contract) have very little to do with that big number. They have very little to do with the reported reserves of the Middle East, Russia, Venezuela or the U.S. Oil prices even have little to do with the daily fluctuations in supply and demand.

No, oil prices, more than any other commodity, are driven by fear, optimism and imperfect information.

The Sky Is Falling!

The fear-mongers tend to get the most airtime. Ever since good old M. King Hubbert rang the supper bell at the end-of-the-world cafe, it has been nearly impossible to go a whole week without stumbling across an article proclaiming the inevitable global recession that the mismatch of oil supply and demand will cause. And they get the column inches because they have that one irrefutable fact on their side - yes, Virginia, we're running out of oil.

The full fear-missive reads like this: oil production will reach a natural peak (or did, in the 1950s, the 1970s, or last year), at which point the world faces shrinking supply in the face of increasing demand. Such an out-of-balance market can only lead to a massive restructuring of the world's economy. Dr Ali Morteza Samsam Bakhtiari, an ex-National Iranian Oil Co. expert (bio), is typical of the breed -- he predicts that by 2020, worldwide production will decline from 81 million barrels a day to 55 million, while demand continues to grow. Dozens of scientists, oil industry executives, Republicans and Democrats agree with him. He's not, prima facie, a kook.

But while the numbers sound logical, Bakhtiari leads the charge of the fear brigade by not suggesting methods of dealing with this. Rather, he simply points out that this market imbalance will kick off "power struggles and deadly conflicts" that will define "the very predicament of Mankind."

Pennies From Heaven

The optimists don't deny the vectors. Yes, there is a theoretical maximum out there somewhere; the wells will someday run dry. They just don't think that's all that interesting a story. Cambridge Energy Research Associates (CERA) does their own math on worldwide production and comes up with a very different answer than Dr. Bakhtiari. In a much-covered report in August, CERA laid out a completely believable prediction that worldwide production would climb from 89 million barrels a day to 110 billion barrels a day in 2015, more than covering projected increases in demand.

The reasons behind CERA's predictions are the motherhood and apple pie of the optimistic capitalist: innovation and market economics. In short, as oil (and related hydrocarbon-based energy) becomes more expensive -- even just a little more expensive -- previously unavailable supplies suddenly get interesting. With that interest comes R&D, and just a little more R&D can make that high-hanging fruit look downright attractive. Put the two together and (magic hands!) you have more production.

The folks at CERA aren't kooks either. They base their predictions not on pie-in-the-sky dreams, but on a field-by-field analysis of what's actually coming out of the ground, as well as a look at the new projects companies are actually funding. The difference is that they look at the energy industry as a modern, new-economy hotbed, and not an old-school extractive dinosaur; an industry more akin to biotech than timber harvesting.

The Sensible Middle

Like so many polarized arguments, the reality is somewhere in the middle. When predicting the future, the only 100 percent guarantee is that nobody actually knows what's going to happen. Yes, oil demand will rise. Yes, there's only so much of the old, easy-to-find stuff lying around, even if we don't know where all of it is. But it's also true that betting against innovation has never been a good long-term play, and very rarely do market forces so completely fail that the human race resorts to boiling rats for dinner.

In the end, the oil market -- not the Feb 07 contract, but the long-term real value of oil -- is driven by perception and imperfect information. This shouldn't be news to any investor. All markets share these two factors deep inside their ugly sausage-factory inner workings. The danger is in thinking that commodities -- especially energy commodities -- are somehow immune. Are 159 liters of oil today really worth $15 less than they were three months ago? Does that barrel actually produce less energy; get less work done in the economy? No. It's perception that's changed. It's rarely the oil on the docks today that set the price, it's the oil that might or might not be there tomorrow.

Or next week.

Or in 2015.