Here’s a fun question to lighten gloomy days in self-isolation?
Here’s a fun question to lighten gloomy days in self-isolation? If the separation rate amongst your regular pairs of white swans suddenly rose to the typical divorce rate numbers recorded amongst wedded couples in Western Europe, would that qualify as a Black Swan event? It would certainly be unexpected as swans are renowned for being lifetime monogamous, while over 30-40% of marriages in Western Europe end in divorce, according to most statistics.
This proposition is not quite as silly as it sounds. We are talking here about how the impact of the highly improbable according to Black Swan theory. The topic is more than pertinent in these troubled times when many personal and work lives are wracked by bewilderment over the Covid-19 pandemic and oil industry woes.
For the uninitiated, black swan musings stem from the writing of Nassim Nicholas Taleb, a US-based Lebanese intellectual and former Wall Street entrepreneur. His bestsellers, notably The Black Swan first published in 2007, and other reflections on probability (Fooled by Randomness, Antifragile, and Skin in the Game) have fuelled a continuing debate between economists, philosophers and social scientists about how to define and manage major events that were not or could not be foreseen.
Taleb’s impact has a lot to do with his ability to unravel and popularize complicated theory by making it personal, sometimes obsessively so. The Black Swan, for example, is peppered with numerous, often humorous, oft times self-aggrandizing, anecdotes about his journey from a childhood in civil war Lebanon to the US, experience as an options trader in New York, and meetings (long walks being his preference) with other thinkers.
He also displays an enviable knowledge and grasp of a huge amount of literature on philosophy, mathematics, and economics. He is not afraid to disrespect almost the entire economist profession, especially Nobel Prize winners, for their wrongheaded statistics-based forecasting methods. Geoscientists should be interested in his dismissal of Gaussian and Bell Curve distribution as the root of much misunderstanding of probabilities.
A Black Swan event in normal parlance simply means some dramatic event that was not anticipated and has severe consequences, most often in a business context. Yet the theory dives deeper. Taleb hijacked the term from the discovery in 1697 of the existence of black swans in Australia made by the Dutch explorer Willem de Vlamingh. This apparently had a significant impact on the science world. Up to that moment all swans had been assumed to be white. Earliest reference to a black swan (imaginary in this case) is usually attributed to the 2nd century Roman poet/satirist Juvenal. He wrote in Latin ‘rara avis in terris nigroque simillima cygno’ (a rare bird in the lands and very much like a black swan). Perhaps best not to dwell on the fact that Juvenal was actually referring to the possibility of a perfect wife.
Black Swan theory was developed by Taleb to address those events that are rare and unexpected (outliers), have extreme consequences when they occur, and in retrospect (unhelpfully) can be explained as something that could have been predicted. Historical examples cited by Taleb include the First World War, emergence of the internet and 9-11. He was also prescient about the Black Swan 2008 financial crisis, making profitable bets in the belief that the financial system was fragile and unsustainable, contrary to the nearly ubiquitous view at the time.
For extremely rare events, Taleb’s argument is well summed up by Investopedia, stating that ‘the standard tools of probability and prediction such as the normal distribution do not apply since they depend on large population and past sample sizes that are never available for rare events by definition. Extrapolating using statistics based on observations of past events is not helpful for predicting Black Swans, and might even make us more vulnerable to them’. This is the problem of induction.
Confusingly perhaps as it involves another bird analogy, Taleb cites the plight of the turkey as an example of how the viewpoint determines whether an event is seen as unpredictable. From the turkey’s perspective, life on the farm being fattened up could hardly be more idyllic until a few days before US Thanksgiving or Christmas in many countries. That’s when a truly Black Swan event occurs … no doubt about this being an outlier with extreme impact and explainable after the event (to the consumer but not of course to the unsuspecting turkey on the dinner table).
Grey swans, meantime, are known unknowns. One example here would be that we don’t know how fast a man or woman can run 100m. However, we do know that we don’t know the answer. A Black Swan on the other hand is an unknown unknown, in other words we are not even aware that we don’t know something.
We can probably skip the several reasons provided by Taleb why we humans are not inclined to allow for the totally unknown, much of it caused by a psychological clinging to the familiar. The upshot in his opinion is that we do not do enough to mitigate the possibility of the Black Swan event. In the financial world, he argues that being a medium risk investor is a poor choice. Better he says to adopt a hyper-conservative investment strategy for 85% of a portfolio combined with a hyper-aggressive attitude to the other 15%. This allows for the possibility of putting big performance numbers on the board that easily beat the average while at the same time protecting against the negative impact of the Black Swan event. Another less convincing approach is to work with an even more speculative portfolio but insuring against losses greater than 15%. Taleb concedes that this may not always be possible.
The real point of Black Swan theory is the futility of trying to predict the future. In this context Taleb has stated recently that he does not consider the Covid-19 pandemic a Black Swan event. His reasoning is that the possibility had been well canvassed before it happened. For example, The Coming Plague by Pullitzer-prize winning journalist Laurie Garrett was published in 1994 and was the culmination of published work dating back at least 10 years earlier. Bill Gates has been warning of an epidemic outbreak for years and Taleb contemplates a virus scenario in The Black Swan.
That countries did not pay enough heed to the pandemic threat is another story, but unsurprising. It would have been challenging for governments to persuade people to invest tax dollars as a precaution against something like a pandemic, not experienced in recent times. The Spanish flu of 1918 that infected an estimated third of the world’s population and possibly killed as many as 50 million people worldwide is too long ago to be remembered. Nothing was apparently alarming enough about the SARS, HIV/Aids and Ebola crises’ in recent decades to stimulate much preparation for the current pandemic.
The same syndrome probably does a lot to explain the slow-motion international action on climate change. John Elkington, a renowned international authority on corporate responsibility and sustainable development, investigates the dynamics at work referencing Taleb in the title of his new book Green Swans: the coming boom in regenerative capitalism, published in April. Risking the opprobrium of a forecast, he says his book is ‘the tale of the accelerating transformation of capitalism, markets, and business – a process, I believe, will reach a major inflection point in the 2020s. The result will be a world of either Black Swan breakdowns, among them climate change emergency and species extinction, or of breakthrough Green Swan solutions. More likely, of course, it will be a shifting mix of both, challenging us to move the needle from black to green.’
For the time being, the experience of the oil industry in these last few months qualifies as a genuine Black Swan event. A triple whammy has been in play. Of course, there is nothing new in sudden oil price collapses, or hikes for that matter, so no Black Swan there. Nor was there anything unpredictable about the collaboration between Saudi Arabia and Russia to punish the US shale oil industry by flooding the market with oil. It is less easy to imagine how oil companies could be expected to anticipate a pandemic on the current scale and its impact on demand, at one point dropping oil prices into negative territory. Put these three factors together, and you surely have a Black Swan event.
Oil companies have exhibited little sign that they had any Plan B precautionary insurance policy to meet this unprecedented combination of circumstances. Probably even Taleb would have trouble offering advice. As a result, oil companies, spurred by the short-term exigencies of their share price and stakeholders, have done what they always do. They have called for draconian cuts to their E&P budgets oblivious of the impact that this may have on the service side of the business but aware that post-Covid-19 must see a recovery in demand.
Ironically, the service industry might survive better than could be expected. Since 2014 it has had the hatches down and been operating in survival mode. Prior to the pandemic outbreak, a number of the key seismic players had fortuitously restructured their finances to free up some cash, so they have some contingency funding to meet the challenging period ahead.
The Black Swan school of thought would recommend that analysis speculating on what will happen next should be treated with scepticism because of the inherent limits of forecasting. This does not make it easy for energy agencies and similar. They play an important role in generating data to model global energy supply and demand for a wide audience of government, industry, financial sector, etc. The methodology behind models will always be open to question whether it is oil price, climate change or some other issue. However, despite Taleb’s admonishments, it is hard to fathom how an allowance can be built in for Black Swan events.
Meantime, as to the improbable question posed at the beginning of this article, Crosstalk recommends consulting the oracle himself, Nassim Nicholas Taleb.
‘Geoscientists should be interested in his dismissal of Gaussian and Bell Curve distribution’
‘The experience of the oil industry qualifies as a genuine Black Swan event’
