The Good, The Bad, And the Inaccurate Oil Forecasts 39 comments
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Here's the good oil forecast: back in the fall of 2005, I predicted oil prices going back down to $35.
Here's the bad forecast: I said it would happen by the end of 2006.
Right price target, wrong time span. So what went wrong?
The process behind the forecast is still sound, I think. World demand for oil can change quickly as the economy grows. World oil supply cannot change quickly, because of time lags in exploration and development (which means putting in the production wells, laying pipeline, building terminals and docks). So oil price rises in the face of growing demand and slow supply response. And oil prices have to rise a lot, because in the short-run demand is not very sensitive to price. Changing oil demand because of price requires changes in equipment and usage patterns, which does not happen quickly. So it takes a big oil price change to bring demand down to current supply. But so far we're in the short run.
In the long run, supply increases. It takes a few years, but supply increases. Demand relative to output slows down. Again, this response takes a few years. That by itself would be enough to bring prices down. My mistake: I expected this process to occur over the course of two to three years.
How was I wrong? Two possibilities: 1) I was mistaken about how long the supply response to price would take, and how long the demand response to price would take; or 2) I misjudged the additional increase in demand from the strong world economy.
I don't know the relative importance of these two errors, but I suspect they are both major contributors to my (and others') forecast errors.
So what's the outlook? I don't know. We're much closer to an equilibrium in which the price at which new supplies can be brought to market matches the price that people are willing to pay. But the market is tremendously volatile.
Business strategy for dealing with oil prices: don't bet your business on a forecast. Not mine, not anybody else's. I don't know of anyone who predicted both the rise to $140 and the drop back to $35, and made the predictions publicly with dates attached. (It's easy for me to say oil will go back over $100 if I don't have to commit to a time period. Maybe 2045?)
If energy costs are critical to your business, look for ways to hedge. Certainly continue to look for cheap ways to become more energy efficient, but keep in mind that a large capital expenditure to lower energy costs is a big, big bet. If betting on energy is not your core competency, don't do it.
What will the next forecast error be? Someone will ask, so let me say now, that's a stupid question. It's asking for a self-defeating prophecy. If I knew what my next mistake would be, I wouldn't make it.
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This article has 39 comments:
I think one thing you can say is: "what comes down must go up."
But as with all markets (including oil), timing predictions and swings are almost always wrong.
Good News Economist
On Dec 21 07:43 AM guliamo wrote:
> I'm currently in DXO - betting we'll see Oil back at $70 in no time.
>
> jack
On Dec 21 08:05 AM john s. gordon wrote:
> you discuss demand/supply but there is no mention of the speculative
> excess occurring in all commodities 2007-2008/
The question is when will it bend.
Will it alter its course,
through some unforeseen force,
and reach its inevitable end?
As for your failure to discuss speculative excess, take my advice and don't worry about it, because while there was speculation, there was no excess.
therealnews.com/t/inde...
The crash was in fact due to privious too low prices because the growth was not sustainable. If the price of oil goes even lower, the prospects for future prices are even higher than the last peak as expensive to run facilities and wells will shut down as they will lose money to keep them going but the demand would be higher as more countries use more power due to the expected growth.
Its your choice, if you don't pay now, then you will pay later and the peak will be even higher next time and the pain would be even worse next time around. The price of oil "has" to be high enough for alternative energy to develop. There is no free production of cheap energy because you don't want to pay for it.
So remember, the lower it goes, the higher the expected peak next time will be.
One thing is sure, a lot of people have lost a lot of money speculating.
Perception is always the key. It is applied to commodity prices as well as to stock prices. And the public only enters after a prolonged upturn in either.
IMO
Oil sands, and many other innovative production techniques, are not economically viable with oil prices this low ($60/barrel seems to stick in my mind). Anyone care to comment on the effect this will have on production?
One other thing that must be remembered is that in the oil market, unlike some other commodity markets, supply is largely dictated by an international cartel that seeks only one thing: abnormally large profits.
I do not know how many Tankers exist worldwide with this classification, but it seems like an attempt to counter falling charter rates.
Will this turn into another Cartel type operation?
I don't know, FRO is the latest to enter it.
This is a purely informative post.
oiltradersblog.blogspo...
If you invest in alternative energy you really don't have to figure out anything.
If the price of oil rises then it will lift the profitability of alternative energy as, well, an alternative. If the price of oil doesn't rise, we have ample assurances from the president-elect and congress that support of development and use of alternative energy will be a key component of a massive, massive stimulus package.
As an investor, why would I even bother trying figure out what is going to happen with oil prices when alternative energy is already in my hotel room, drunk and wearing a french maid costume?
I am overweight in alternative energy investments (and have taken a bath in the last six months), but this is an area with bubble potential. If you buy the alternative energy equivalents of Microsoft, Intel and Cisco from 1990, you will acquire great wealth. If you are loaded up on the equivalent of dot.com busts, woe is you. You need to be wise, lucky and patient (long time horizon) in this area plus be disciplined enough to unload the weak and lighten up on the strong when in the bubble.
I believe the greatest investment opportunity in front of us right now is oil and oil related stocks, IF
1. You can tolerate an uncertain time horizon (1 year or several years).
2. We do not spiral into a 10 year or longer global depression.
3. Alternative energies do not experience what (seems to me to be an unlikely emergence) to dominance within 5-10 years.
The downside risk to oil investment with oil $30-$40 is relatively low. If it breaks below $25 the downside risk will be virtually nil. I am taking small positions in this area now and will be scaling in over the next months, more quickly if oil gets into the 20's.
"....experience (what seems to me to be an unlikely) emergence to dominance within 5-10 years."
I apologize for neglecting to complement you on your fine article. We all benefit from self analysis of missed opportunities and failures and don't (at least I don't) do enough of it. When someone like you shares such analysis it both unusual and helpful to others. I expect it is helpful to you as well, because it ensures that your self analysis ties up loose ends. I recall from my student days that I got my best grades in courses where I tutored others. I now realize I was tying up a lot of loose ends that I would not have otherwise recognized existed until during and after the exams.
Everytime I read the prospectus of an alternative energy company I am left feeling that I have found the next microsoft. This forces me to conclude that I have no clue and no ability to separate the wheat from the chaff in this area. So I let the Wilderhill clean energy index do that for me with an investment in PBW for now.
While my strategy sacrifices the biggest returns, it also should minimize the downside risks. This approach is also more consistent with my core competence, which is macro trends and the big picture. I realize this identifies me as an amateur but, hey, at least I know it.
I may make smaller gambles on specific companies to try to goose returns and, well, for fun. Kicking myself that all my cash was tied up and I couldn't buy FSLR when Steven Chu was appointed energy secretary. Can't win 'em all.
Thanks again.
In the stock and commodities markets it is usually easier to predict WHAT is
going to happen than WHEN it is going to happen.
The next terrorist attack of scale will drive oil over $100. Sure. But when?
Take Indium for instance, LCDs?, the Chinese just picked up 700,000 pounds. The LCD market isn't exactly in a demand phase right now. Some expect them to pick up a bunch of copper next.
Kitco.com
It won't take very long to realize that demand is picking up. IMHO
If the wall street analysts are just using models to chart numbers by plotting lines, I think college students can give an equally capable number. The use of models without science is just ridiculous with the amount of money they make to make insightless recommendations.
Even if Oil's downside is another $10-20, the risk / reward is one of the best oppurtunities currently:
1) Illiquidity continues to prevail. Hedge funds must raise cash and are forced to sell. Oil is under short term pressure.
2) to paraphrase Jim Rogers -'they have to cut down new forrests inorder to keep up w the Fed's new money printing press'- dollars will become less valuable over time and Oil, priced in dollars, will benifit.
(At this level, Oil is also priced here where is has been off and on where it has been over the last 20 years, at peaks. Dollars today- even w the short term deflation argument- are less valuable than in 1988.)
3) Has demand really waned as fast as thought? I dont know- but I am skeptical of this key argument for cheap oil.
4) emerging markets growth has slowed- but will conitune to grow. Oil goes up.
5) Current prices cut the NPV's of future supply projects- including ones for alternative energy. Oil goes up.
6) Lastly, unlike any number of securities, oil will never go to zero.
These are just my own personal observations. Let me know any counter arguments.
JC
I have no counter arguments. I think you summed up the uncertainty well (and the important certainty that oil will not go to zero in the next 10-20 years). Actually, it will never go to zero because it is an important raw material and doesn't have to be burned to be valuable.
We are in a reversion right now. If oil drops another 50%, I'll sell my children to buy DXO.. (By the way... Interesting posts here about the possible downside... I'll have to check it out..)
Oil is necessary for many aspects of our civilization that are not related to gassing a car. Medicines, plastics, fertilizers etc.. all need oil production. (And yes.. I do know about switchgrass and blue-green algae..Been a sci-fi reader all my life..... Look up "gobar gas"... We just don't seem to actually pursue these alternates..) In the next year, oil will be up to the high 60s and the year after touching 100.... The alternative is we have a global shutdown...
..By the way... Love the drunk French maid... Almost lost track of this whole thread..
jegan ;-)
I vote with you with most of my money right now.
On Dec 21 10:52 AM axelrod608 wrote:
> I'm putting my oil money in Canadian and US producers that are pipelined
> into the American market. If demand drops, we'll ship in fewer tankers,
> but the pipelines will keep flowing. We WILL continue to burn a lot
> of oil. And we'll get it locally first.
Some think Mexico could become a net importer within the next three years unless it changes course about Foreign ownership.
Anyone notice the recent Citco gas pricing. It appears to me, at least in the midwest, that their prices are higher than other Gas stations. They now have to pay more to refine the Heavy Grade which is no longer in demand.
IMHO
Wow.
You must have missed one of Carmela's speeches in "The Sopranos" where she explains to Tony "let me tell you something, or you can watch the f**king news... everything comes to an end."
In the USA discoveries of petroleum peaked in the 1930s, and continued to decline thereafter. We still find petroleum, but we find less each year - and the individual fields are smaller and more expensive to extract. When production started to fall in 1970, it was inevitable -- you find less, eventually you produce less.
That pattern has been repeated in many countries before and since 1970. Worldwide, discovered peaked in 1964, and thereafter each year we find less, and we find fields that are smaller, and much more expensive to extract.
Eventually -- and this has also happened in some years in some countries -- the cost of exploration to find more doesn't justify what's found.
The added madness is we don't WANT to find more -- because we've also noticed that the more co2 pumped out by burning fossil fuels, the more the Earth's tempurature rises. We're at the stage now where a few more decades of that pattern could be catastropic permanently.
One of the factors overlooked by cornucopians (those that believe there will ALWAYS be more) is the decline in the qualtiy of what we discover. The percentage of copper in what made good copper ore was around 3%+ in 1850, but little over 1% by 1900 and 0.5% today. Similar things are happening with steel and other metals. One of the big undiscussed reasons for America's rust belt is the Minnesota Mesabi range with its mountains of 40% (and higher!) percentages of iron are gone now, as is most of the nearby antracite. The cheap raw materials that made Cleveland and Buffalo and Pittsburgh so rich are done.
Everything comes to an end.
Tilyou1
On the monthly chart, oil is clearly now on the 4th wave similar to Nikkei 225 of late 2005. They have so many similarities only that oil went into a superspike greater than Nikkei did on 2005. My maximum target at that time to the upside was $115 for oil without a superspike. GS was able to predict the superspike to $145. Since the spike was unsustainable just like Nikkei 225 of late 2005; the ensuing correction was also drastic and was able to consume less time than the rally.
Most charts of this characteristic superspike of the the 3rd wave results in "super-super spike" correction or some chartists call a dip trip that then results in slow finalyzation of the 5th wave to the upside. Most chartists at that time would not believe such a spike run could be sustainable.
An example is also Hangseng and Senzhen indexes on the monthly charts with the 3rd wave and 5th wave going over-extended run until 2007 similar to Dow Jones of the late 1920's ending in 1929. The resulting correction was horrible when the 3rd and 5th waves of the 1-2-3-4-5 run over-extended. Oil has the iii-rd wave and v-th wave of the 3rd wave going over-extended resulting in a correction similar in fashion with Dow Jones of 1929-1932, Nasdaq of 2000-2003, and Hangseng of today from 2007 - only that they are at different stages and time frames but have similar sub-stages going into over-extented runs to the upside. Use fibonacci run; anything over 262% price projection of the previous price run is over-extended and is therefore unsustainable.
Optimistically, Oil should be able to rally slowly to $177 in 3 to 7 years.
Use Nikkei 225 rally from 2005 to 2007 as a template for the highest probability scenario.
Oil has a bigger time frame template than Nikkei 225.
Bet on the odds. There are lots of possible scenarios but the most common is the highest probable.
Supply and demand doesn't fully explain it.
OPEC activity doesn't explain it.
Peak oil theories don't explain it in the several-years short term that we're interested in.
Technical analysis doesn't explain it, except in hindsight, to a degree, at some points in history.
Oil has a uniquely inelastic, nearly vertical, short term supply curve that causes tiny changes in supply or demand to have drastic effects on price. It is also priced on a futures market that is prone to its own supply and demand curve fluctuations and that responds to every car bomb, cold front, or interest rate fluctuation in the world. It's not that oil has no fundamentals, it's that it has thousands of fundamentals, which makes it more like a psychology experiment than a market for goods. If you disagree, again, show me a person, model, or method that predicted recent history. This makes for exciting, if dangerous, gambling. I might gamble a few hundred bucks on DXO once the trend reverses at $15-20/barrel, but nothing more and with tight stops. I think we're all acutely aware that no one, including ourselves, knows what oil will do next. To claim otherwise would be pure arrogance.
The same peak oil theory became popular in the last 2 years. It does take supply time to come onto the market. When demand drops off however watch out! The predictability of Oil prices is very hard and few make money on it.
Oil prices could easily hit $20 as the Middle East producers need to keep cash rolling in. Any target they set will be cheated on. In addition when the Oil tankers are all full and storage is all full prices will bottom. Oil will be offered at whatever price can be had.
The takeaway is that Oil is a boom and bust business that has a history of long cycles and punishes unmercilously with its rapid decline and its long tenured down cycles. Let it hit bottom and let the economy improve before investing. Then let the huge storage get drawn down before investing. You will be glad you did as it may take 3-12 years.
After all of that you may have a nice profitable decade of outstanding and spectacular returns that build strong and steady... It is sweet when you hit it right.