Great Expectations (for higher oil prices)

Much attention was garnered last year by those, like T. Boone Pickens, who predicted oil prices rising to $200-300 per barrel with a year or two, but less attention has been paid to the recently revised forecast of the US Department of Energy, published in preview of its Annual Energy Outlook. The Outlook appeared in January, when prices had already plummeted, but was presumably written earlier, when prices were higher. It included the seemingly moderate forecast of prices rising to $70 by 2010 and $110 by 2015, as the figure shows.

US DOE 2008 Oil Price Forecast

(2007$/barrel)

While many of the alarmists will no doubt seize on this as evidence of tightening markets ahead, and use graphs such as the above to illustrate the ‘reasonable’ forecast of ‘moderately’ rising prices, this is only because of the lack of perspective. During the debate three decades ago, when some claimed that Harold Hotelling had proven mathematically that oil prices had to rise at 3% per year above inflation (which was in fact a misinterpretation of his work), the rising price forecast from groups like the Dept. of Energy seemed to support this argument, also appeared moderate when published without the historical context. But considering the second figure, below, it becomes apparent that this forecast is in point of fact quite remarkable and indeed rather fantastic, given the historical context.

DOE Forecast in Historical Context

(2007$/barrel)

Arguably, events such as political instability in the Middle East could keep prices elevated for some time, but historically, commodity prices have been mean-reverting. The problems and challenges facing today’s oil industry, somewhat alleviated by the price collapse, were all transient or cyclical in nature, including shortages of advanced equipment and trained personnel, disruptions to Iraqi, Venezuelan and Nigerian supply, and resource nationalism. Indeed, the Venezuelan regime is already moving to reverse its earlier repudiation of foreign oil investment. A similar policy reversal in the 1990s led to soaring supply and pressure on OPEC that culminated in the 1998 oil price collapse.

Further Reading:

Adelman, M. A., “Mineral Depletion with Special Reference to Petroleum,” Review of Economics and Statistics, February 1990.

Lynch, Michael C., “Bias and Theoretical Error in Long-Term Oil Market Forecasting,” in Advances in the Economics of Energy and Natural Resources, John R. Moroney, ed., JAI Press, 1994.

Lynch, Michael C., “A New Era of Price Volatility?” Oil & Gas Journal, 2/12/01.

Watkins, G. C., “The Hotelling Principle: Autobahn or Cul de Sac?” The Energy Journal, 13(1), 1992.