A New Era of Oil Prices (What? Again?)

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The biggest story in energy at the moment is the oil price. Back in the middle of 2014 the markets were basking in a world of $100/bbl oil and more. Prices had been around there, except for brief excursions, since early 2011. And there was no real expectation that things would change. In its June 2014 short-term energy outlook the US Energy Information Administration was saying in its Short Term Energy Outlook (STEO) :

“This [i.e. June 2014] was the 12th consecutive month in which the average Brent crude oil spot price ranged between $107/bbl and $112/bbl. EIA projects Brent crude oil prices to average $110/bbl in 2014 and $105/bbl in 2015, $2/bbl and $3/bbl higher than projected in last month’s STEO, respectively.”

And the long-term outlook was for more of the same, with authoritative agencies such as the EIA and the International Energy Agency (IEA) projecting that oil prices were likely to continue to increase in real terms .

Practically everyone got it wrong and, of course, oil prices have dropped to less than half the level they were in June, and the EIA’s latest STEO is now confidently saying that Brent crude oil prices will average $58/bbl in 2015 and $75/bbl in 2016.

We shouldn’t be too hard on the forecasters, because the oil price seems to be inherently unforecastable – as, indeed, several academic studies of the accuracy of historical forecasts have demonstrated. This track record should make us view with healthy skepticism the confidence with which some are now predicting a new era of low oil prices.

But a reasonable person will ask how it was that the oil price dropped so very rapidly in the second half of 2014 if the factors which are now blamed for the fall (US shale oil, economic performance) are things that have developed much more slowly? Many will blame financial trading for this sort of volatility, as a key factor setting oil prices is the futures market, which functions as much through expectations as firm supply and demand fundamentals. Certainly this was the view expressed in Daniel O’Sullivan’s excellent book “Petromania ”. Published in 2009, this book reviews the reasons for the enormous swing in oil prices in 2008, when the Brent price peaked at $147/bbl in July before falling to $34/bbl by Christmas. O’Sullivan lays the blame for the unpredictability fairly and squarely on the financial traders – although other experts would dispute this – and his analysis of the last oil price collapse makes for essential reading for anyone trying to understand what is happening today.

For those looking for a more technical explanation of oil markets, Salvatore Carollo’s “Understanding Oil Prices: A Guide to What Drives the Price of Oil in Today’s Markets” provides an excellent grounding, while, as always, Daniel Yurgin’s The Prize provides an impeccable survey of the historical background.