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Page added on April 30, 2015

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Michael Lynch: Lessons In Oil Price Forecasting

Consumption

When I published a working paper in 1992 at MIT called “The Fog of Commerce: The Failure of Long-Term Oil Market Forecasting,” many thought the lesson was that forecasting the long-term price of oil couldn’t be done. My actual point had been that bad theories and bad models lead to bad forecasts, specifically the belief that resource economics proved that fossil fuel prices had to rise exponentially.

Recently, I opened a talk with a slide showing the early-2014 survey of long-term oil price forecasts published by the Department of Energy, in which my forecast of $50 a barrel was far below all the others. But in the next slide, previous forecasts in which I had called for lower prices for the past ten years were included, in part, because I don’t want to cherry-pick my record (the way some peak oil advocates do), but also to focus the discussion on pertinent lessons from forecasting, not just the accuracy of any given prediction.

This is important because too many of late have been drawing superficial conclusions about forecasting, whether it is that it can’t be done (as many do) or Al Gore’s triumphant note that predictions of the failure of renewables have proved wrong, therefore the energy transition is under way. (Technology predictions will be addressed in a later post.)

The lesson to be drawn from the many oil company “Titans” that were convinced lower prices were unlikely or incredible is that they tend to let wishful thinking dominate their expectations, an all too human failing. T. Boone Pickens, claiming “…because I know more about it than they do,” shows that he hasn’t learned from the ancient Greeks about hybris, or pride, to say nothing of his own mistakes. Anyone who has been in the business of predicting oil markets should be pretty humble, because we’ve all gotten it wrong many times, sometimes spectacularly.

As noted in an earlier post, my 2012 prediction at the OPEC International Energy Seminar that long-term oil prices would be $50-60 a barrel had met with skepticism and derision, and my submission to DOE last year brought the response, “Have you been drinking?” (Well, yes, but that’s beside the point.) It’s true that for the past ten years, the oil price has been about $90 a barrel, but for the previous 140 years, the average price of oil, adjusted for inflation, was roughly $30 a barrel. Thinking the price might be $100 for the next 20 years is one thing, but how can $50 be inconceivable to so many?

This is, to my thinking, the most important lesson: the narrow-mindedness of so many, not just in the analytical community, but in the industry. Naturally, there is a desire not to commit a memorable mistake, and fit within the herd, but there is still a need to consider a broader range of outcomes.

Dan Gardner’s excellent book Future Babble argues that people prefer certainty in their pundits, and many oil market prognosticators appear to have absorbed this lesson. Even ignoring the question of shale oil production at $60 a barrel, can anyone know how much oil will come from Iran and Libya a year from now? (Well, the Ayatollah Khameini might have some idea.) There’s a credible range of 2.5 mb/d difference between current production, and depending on where on that spectrum supply falls, oil prices could easily drop $20 or rise $20.

Considering various reviews of oil price forecasts, then, realize that any given prediction can be wildly wrong. But for decision-makers, understanding that and knowing why they might go wrong is crucial. The market has repeatedly moved in ways thought impossible, on both the high and low side, and too many oil companies have suffered because their strategies reflected either a narrow vision of future prices or, quite simply, senior executives’ wishes.

Forbes



20 Comments on "Michael Lynch: Lessons In Oil Price Forecasting"

  1. BobInget on Thu, 30th Apr 2015 10:27 am 

    In spite of remarkable advances in technology
    it simply costs more to wring oil from discarded
    writes-offs once classified as ‘not commercial’.

    Today, it seems, ‘dry holes’ are a thing of the past.

    The Forbes piece gives short shrift to the fact that oil has averaged $90 for ten years for good reasons. Forbes is saying markets were wrong in the same decade that brought industry so many
    technical advances in exploration and lifting.

    Well, there were of course those horrendous, oil inspired, series of Middle East wars starting in Iraq spreading like cancers to every corner of the region. These wars, so easily dismissed by Forbes, had the effect of diminishing oil reserves,
    destabilizing de facto oil suppliers, forcing prices
    to unaffordable levels, not to mention killing and displacing millions in the process.

    Because the West persists in the fiction of ‘Cheap Mideast Oil’ wars, now metastasized
    into religious conflicts, will follow all of us to our old ages. The old saw: “Pay me now, or pay me later” comes to mind.

    Currently, traders pay no attention to what happens next week much less next decade.
    Outrageous rents in New York and London need to be paid monthly. The coke dealer demands cash. Preschools, nannies, cost like that trader’s Harvard student loan.
    IOW’s, who gives a shit about what some “Rag-Head” says or doesn’t say. Until missiles are actually in the air, it’s BAU.

  2. Dredd on Thu, 30th Apr 2015 10:36 am 

    many thought the lesson was that forecasting the long-term price of oil couldn’t be done

    Back then you could not convince as many people that big money could be made selling people the poison that would kill them.

    Especially at sky high prices.

  3. shortonoil on Thu, 30th Apr 2015 11:05 am 

    http://www.thehillsgroup.org/depletion2_022.htm

    Lynch – a projection without a model.

    12 dart boards, 3 Ouija boards, 1 can dried chicken bones, 2 horseshoes hung above the door, and a box of woolly caterpillars (with stripes).

    A virtual Sage– (in the 8th century)!

  4. rockman on Thu, 30th Apr 2015 11:23 am 

    It should be easy to ID someone whose forecast at anyone point on time was accurate. Just like it’s easy to ID someone with the amazing power to pick the one winning lotto number out of the 16 million possibilities: that’s the guy who won the lotto last time.

    BTW I’m not sure if this fellow is saying he correctly picked $50/bbl oil but if he did it wasn’t really that impressive if he ONLY counts the price on any given day. The person who will really impress the sh*t out of me is the one who accurately predicts the average price over any 12 month period. And do it over a 24 month period and I’ll organize a parade for him. LOL.

  5. nony on Thu, 30th Apr 2015 12:07 pm 

    The futures mkt was back warded so some drop prediction was rational. Given how prices came down it seems reasonable to say that we were overpriced for a period of time. People did not give us lot enough credit. Also there was an expectation of cartel action.

    James Hamilton looks really silly with his hundred dollars to stay and especially for not doing a post mortem.

  6. Perk Earl on Thu, 30th Apr 2015 12:19 pm 

    From a post by Jeffrey Brown at Peak Barrel dot com.:

    Michael C. Lynch (August, 2009): ‘Peak Oil’ Is a Waste of Energy
    http://www.nytimes.com/2009/08/25/opinion/25lynch.html?pagewanted=2&_r=3&emc=eta1

    “Oil remains abundant, and the price will likely come down closer to the historical level of $30 a barrel as new supplies come forward in the deep waters off West Africa and Latin America, in East Africa, and perhaps in the Bakken oil shale fields of Montana and North Dakota. But that may not keep the Chicken Littles from convincing policymakers in Washington and elsewhere that oil, being finite, must increase in price.”

    Brent averaged $110 for 2011 to 2013 inclusive, and it averaged $99 in 2014.

  7. Plantagenet on Thu, 30th Apr 2015 12:42 pm 

    Lynch deserves credit for spotting the potential for an oil glut and price drops before they occurred.

    Very few people were able to see this coming.

  8. nony on Thu, 30th Apr 2015 1:09 pm 

    ironic given 1986. More people need to read the Prize. Lot of the current peaked sentiment and alternative energy is a 1970s repeat.

  9. GregT on Thu, 30th Apr 2015 1:17 pm 

    “Very few people were able to see this coming.”

    Kind of difficult to see something coming when it never did. Unless of course, people like making stuff up.

  10. GregT on Thu, 30th Apr 2015 1:19 pm 

    “Lot of the current peaked sentiment and alternative energy is a 1970s repeat.”

    Absolutely correct Nony, except that this time it isn’t only the US that has peaked, and we don’t have another planet to exploit.

  11. shortonoil on Thu, 30th Apr 2015 2:14 pm 

    Annual WTI prices/ $barrel, EIA

    2008….94.04
    2009….56.35
    2010….87.48
    2011….71.21
    2012….94.05
    2013….97.98
    2014… 93.26

    “Add in syndicated bank loans and total borrowing by the oil-and-gas sector rose to $2.5 trillion at the end of 2014, up from $1 trillion of outstanding debt at the end of 2006, according to the Switzerland-based Bank for International Settlements. It has warned that an “oil-debt nexus” could create a vicious circle whereby over indebted companies pump more oil to ensure they can pay interest on their loans, adding to the current global oil glut, and further depressing energy prices…”

    http://www.zerohedge.com/news/2015-04-28/debt-pile-fuel-further-oil-price-pressure

    This coincidences with our determinations on the future of petroleum prices:

    http://www.thehillsgroup.org/depletion2_022.htm
    (hit the back button ◄ on your browser to return)

    The petroleum industry has been living on borrowed money since the run up in prices began in 2008. The production cost curve began getting much steeper after conventional peaked in 2005.

    http://www.thehillsgroup.org/depletion2_010.htm

    By our calculations the industry must now raise at least $1.3 trillion per year in extra funds to maintain present production levels. That figure is likely to double over the next year. Because there is an affordability cap that limits petroleum prices, these funds will never be re-payed. Once additional funding can no longer be procured, production will plummet, large scale defaults will commence, and the monetary financial system may cease functioning.

    http://www.thehillsgroup.org

  12. Davy on Thu, 30th Apr 2015 2:20 pm 

    Short, that does not include repair, maintenance, and new construction to keep the oil complex from flunking the civil engineers infrastructure ratings. IMA, replacing charming guys like the Rockman that choose to move to seaside retirement palaces.

  13. Perk Earl on Thu, 30th Apr 2015 4:58 pm 

    “It has warned that an “oil-debt nexus” could create a vicious circle whereby over indebted companies pump more oil to ensure they can pay interest on their loans, adding to the current global oil glut, and further depressing energy prices…”

    That nails it, short. The game is tightening up and sellers have to desperately seek every buyer to insure sale of all oil to run on that razor edge of competition at this stage of depletion. Slack off now and go home.

    Here’s an interesting question you may have an answer for short. Compared to the oil coming out of Pennsylvania at 60′ down by Drake in 1859, what would be the equivalent in today’s depleted oil. If we use for example say 70 mbd crude how many barrels does that equate to in 1859? 20-30-40?

  14. joe on Thu, 30th Apr 2015 6:43 pm 

    In the 1970s spare capacity was enormous, the market was tiny by today’s standard’s . Today’s issues in oil supply are known and obvious. Costs are known. It’s clear that prices will fluctuate until Opec goes totally into terminal decline and prices go up until supply gluts and demand collapses. Instability is the future in oil. Opec already does not meet demand, it’s now fighting non Opec for market share. These are signs of peak oil, not plentyful supply.

  15. BC on Thu, 30th Apr 2015 7:36 pm 

    Plant continues to maintain that there is a glut of oil. I contend that we have unequivocal evidence of Peak Oil at insufficient growth of demand at the necessary affordable prices at the level of unprofitable extraction that will eventually result in a decline (collapse) in production to meet a level of demand that reflects little or no real final sales per capita growth since 2005-08.

    I estimate a 5- and 10-year real, US$-adjusted price of no higher than $40-$60 (from $95-$105 today) indefinitely hereafter at no more than 5-6Mbd of US production and declining consumption per capita.

    US oil production per capita will continue to decline until some time in the early to no later than mid-2020s when the US and world economies will have already begun an inexorable decline in real terms per capita, precluding any mitigating responses, such as accelerated fossil fuel-based build-out of renewables to necessary scale AND sustaining simultaneously the fossil fuel infrastructure.

    The only viable long-term solution left is a managed/planned reduction of net energy consumption per capita; eliminating the rebound effect; taxing away personal auto ownership; taxing highly progressively fossil fuel “energy slaves” of the top 0.001-1% to 10%; accelerating automation of most paid employment; an debt jubilee of 50% or more of outstanding debt; elimination of fractional reserve banking and debt-money, replacing debt-money with state-issued digital net energy credits per capita at no cost and non-inflationary velocity of 1.0 to sustainable fully automated, highly energy-efficient value-added output of goods and services; and redistributing income via a basic income guarantee, requiring in exchange social service, while eliminating all social-welfare transfer programs.

    We’re about 40-45 years behind acting collectively to mitigate the worst cumulative effects on mass-social well-being of the bottom 80-90%, and eventually the bottom 90-99%.

    Scarcity per capita, debt-money-based, global rentier-capitalist plunder benefiting primarily the top 0.001-1%, and successive last-man-standing wars for the remaining resources of the planet are not the enlightened human ape approach to what faces our species and the ecological system of the planet.

  16. GregT on Thu, 30th Apr 2015 8:01 pm 

    BC,

    Too many words. Too many big words.

    Planter is confused enough already. No point in making the situation even more complicated.

  17. GregT on Thu, 30th Apr 2015 8:11 pm 

    BTW BC,

    I agree with your POV entirely. Give or take a few years.

  18. Davy on Thu, 30th Apr 2015 9:21 pm 

    BC, the one issue with your comment I have is I feel systematically we cannot degrowth without a corresponding collapse. A reduction in oil use is a degrowth scenario. There is consequences and unintended consequences to any actions to manage a degrowth like you mentioned. All activity is interconnected in our global system. All locals have been delocalized and dependent on the global JIT production and distribution.

    I would like to think degrowth is possible because we could accommodate less without collapse. We could gently rebalance consumption and population.

    Unfortunately the system is not organized that way at a fundamental level. Globalism made us dependent on each other without the connection. There is no motivation or protocol to degrowth among nations. Climate negotiations are an example of failed cooperation. Nature will be the moderator not man.

  19. shallow sand on Thu, 30th Apr 2015 10:45 pm 

    Unless I am mistaken, Mr. Lynch has predicted low prices for the last 15+ years. So he was correct late 2008-early 2009 and from Thanksgiving 2014 through today.

    As I wondered elsewhere, how has he seemingly ignored the tremendous run up in CAPEX and production expenses? My own estimate is these have tripled to quadrupled since the oil price run up started in 2002.

    For Mr. Lynch to be correct long term, CAPEX and production costs need to drop significantly and/or demand needs to drop significantly. I don’t see evidence of any of these things happening yet.

    It appears with the price crash that expenses are dropping some. I also assume tech advances will drive down costs. But I think he was predicting $30 oil long term after the last crash. I don’t see us getting anywhere near there. As for his recent long term $50 prediction, look at recently released earnings for WLL and COP. Both lost $$ in the first quarter of 2015 with prices hovering around $50 WTI.

    COP is guiding second quarter production to be below the first quarter. EOG’s CEO stated his company was not interested in growing oil production at $50 WTI. Almost all major oil companies have cut CAPEX in response to $50 WTI. From these actions, it would appear the major oil companies do not foresee costs dropping so low as to make growing oil production at $50 WTI a profitable long term venture.

    Maybe Mr. Lynch sees a major long term worldwide depression. That could result in $50 WTI long term.

  20. shortonoil on Fri, 1st May 2015 11:03 am 

    Hi Perk,

    “Here’s an interesting question you may have an answer for short. Compared to the oil coming out of Pennsylvania at 60′ down by Drake in 1859, what would be the equivalent in today’s depleted oil. If we use for example say 70 mbd crude how many barrels does that equate to in 1859? 20-30-40?”

    The ERoEI curve is actually a logistic curve, although we model it as an exponential curve. For general use we cut the curve off at 1960. It reached its maximum value at about 340:1. It didn’t take much energy to pull a five gallon bucket of oil out of a 63 foot well with a rope!

    To provide the same amount of energy to the end user as 70 mb/d would at present, would have required 16.5 mb/d in 1859. It has been the phenomenal energy density of petroleum (140,000 BTU/gal) that has allowed the world to exploit it for the last 150 years. If that energy density had been 100,000 BTU/gal the oil age would have ended in 1994!

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