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Page added on May 28, 2016

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Why Predicting Oil Prices Is Hard

Consumption

Two years ago this week the price of West Texas Intermediate (WTI) was trading at about $105/barrel (bbl). I certainly hadn’t anticipated such a price, because on January 13, 2014 with the price of WTI at $91.45/bbl, I predicted lower prices for 2014. This was the only of my 2014 predictions that looked questionable at that stage (see Gazing Into My 2014 Crystal Ball), but I just didn’t feel like the fundamentals supported $100/bbl oil. I justified my prediction when I made it:

Domestically, crude oil production is likely to expand again in 2014, and given the logistical constraints and insufficient demand growth in the US, prices will be pressured to the downside. There is the possibility of a recovering US economy boosting demand, but it is hard to imagine that demand will grow as quickly as oil production… Spare capacity is still tight, but some of the hotspots from the past few years, like Libya, are stabilizing. There is also the possibility of seeing crude oil exports from Iran start to pick back up. This may allow global crude oil capacity to gain a little bit of a cushion this year.

I further noted that oil price predictions were all over the map:

The variation of predictions among analysts on crude oil prices through the rest of the decade is wide. Ed Morse, the commodities research chief at Citi, expects crude prices to average $80/bbl through 2020. Oswald Clint at Sanford Bernstein projects nearly double that at $158 a barrel in 2020. I expect that short-term fundamentals are going to favor the lower end of that divide, but we will break to the high side by 2020. Global oil production still has some expansion left, but if it slows before 2020 and demand in developing countries continues to grow at the pace of the past decade, crude prices will break to the upside.

Yet there we were during the last week of May with oil prices about 15% higher than they were when I made my prediction.

Of course we all know what happened next. During the last week of July 2014 WTI dipped below $100/bbl, and then in November OPEC made a decision to put even more oil into an oversupplied market. The price of WTI closed 2014 at just over $50/bbl. Fundamentals ultimately won out, and my prediction was salvaged. But the events of 2014, and indeed through today reiterated an observation I have made many times. The fundamentals of oil prices are rarely based on real time data, and the price can diverge from fundamentals for extended periods of time. That’s the primary reason I dislike making short term predictions on oil prices — it’s just not much better than a guess.

That brings me to this week’s news. After falling into the $20s back in February of this year, this week the price of WTI breached $50 briefly. If you had surveyed pundits earlier in the year, the general consensus was that the news on oil was bearish as far as the eye could see. In fact, during the last week of January The Economist wrote:

The world is drowning in oil. Saudi Arabia is pumping at almost full tilt…Saudi Arabia will also be prepared to suffer a lot of pain to thwart Iran, its bitter rival, which this week was poised to rejoin oil markets as nuclear sanctions were lifted, with potential output of 3m-4m b/d.

And then the money quote:

Forecasting the oil price is a mug’s game (as the newspaper that once speculated about $5 oil, we speak from experience), but few expect it to start rising before 2017.

Yet here we are, with oil prices more than 50% higher now than they were when those words were published. Of course The Economist was hardly alone — and they were correct on the facts. Crude oil inventories are very high, Saudi is pumping hard, and Iran is bringing oil back to the market. How could that be anything but a prescription for lower oil prices?

The flip side of that argument was that the price at that time (~$30/bbl) already reflected all of that information, and investors were well aware that global demand couldn’t be met by $30/bbl oil. That wasn’t a fundamentally sound price for oil, so the price rise reflects something like a return to those fundamentals. There are still downside risks, which is why I told a reporter this week that I felt the oil market had gotten a bit ahead of itself. The short term is itself ripe for a pullback, but longer term I think $50/bbl is still too low to ensure that future production meets demand.

But then I recall hearing somewhere that forecasting oil prices is a mug’s game…

Forbes



2 Comments on "Why Predicting Oil Prices Is Hard"

  1. makati1 on Sat, 28th May 2016 8:26 pm 

    Forecasting the weather is easier and more accurate than predicting oil prices beyond today, but a lot of economists/gamblers try. Easier to guess what number the marble is going to land on in roulette, but a lot of suckers believe they know. Fun to watch the numbers go up and down if you are not invested. ^_^

  2. dooma on Sun, 29th May 2016 12:37 am 

    When you freely admit that you are just guessing about the subject you are writing about-write about it anyway.

    Typical click-bait.

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