Foreseeing $105/barrel Oil: a Reason to Love an Economist

Michael Giberson

At Platt’s The Barrel blog, Dave Ernsberger writes that, “no one particularly loves an economist, especially the ones that work at Wall Street banks.” But then he recalls that, about three years ago when oil prices were about $55/barrel, Goldman Sachs economist Arjun N. Murti briefly became famous in energy and finance circles (or notorious, depending on your perspective) for forecasting that the price of oil would reach $105/barrel.

When the report came out [in late March, 2005], the oil market rallied by more than a dollar as word of his forecast reached the floor of the NYMEX. A day later, crude hit a new record high of $58 per barrel — small change compared to Friday’s settlement of $110.21.

Murti, who was at the time described by Fortune magazine as “press-shy by nature,” became a strange sort of celebrity — largely because commentators thought he was a crank. He became a lightning rod for angry investors, and energy regulators around the world who thought they had found a smoking gun to support the theory that hedge funds and banks were somehow tied up in a conspiracy to drive up prices.

Some accused Goldman Sachs of manipulating the market through the report to benefit its energy-trading desk.

There were calls from some commentators for a government investigation. Hank Paulson — then CEO at Goldman Sachs and now the US Treasury Secretary — himself stood up to defend Murthi at an annual shareholders’ meeting.

So imagine the satisfaction if you are Murthi now.

Rather, imagine the satisfaction if you – as a CEO – listened to Murthi then, and re-positioned your portfolio, hedged your company against the prospects of rising prices, and otherwise took steps to be prepared for the march of oil prices over these last few years. Now that would be a reason to love your economist – or at least to listen to your economist with a little more respect.

Of course, Murthi’s forecast was disputed back then, no doubt by exactly opposite reactions from other economists. A Business Week special report published a month after Murthi’s $105 forecast collected economists’ opinions about the likelihood of $100+ oil and the probable effects of such high prices, some of which forecasts can – with the benefit of hindsight – be fairly called as off the mark.

If crude costs $100 or more a barrel, gas prices will hit at least $4 a gallon. And prices at the mall will have shot up long before oil reaches the $100 mark, says Mark Zandi, chief economist at Economy.com.

Why? After all, even at today’s price of roughly $50, oil costs twice as much as it did two years ago, yet consumer prices have risen a mere 5% since then. The reason is that productivity gains and cost savings from technology investments in the late 1990s have allowed manufacturers to better absorb the impact of more expensive oil. And some producers have chosen not to pass along increased costs to avoid losing market share.

But manufacturers and retailers can contain costs only for so long. By now, most factories are so lean they haven’t any room for further cost cuts or productivity gains. “They have squeezed all the juice out of productivity efficiencies in the past few years,” notes Mark Baxter, director of the Maguire Energy Institute at Southern Methodist University’s Cox School of Business in Dallas.

Crude oil prices are above $100/barrel, yet gasoline prices currently average $3.27 nationwide, so apparently there was a little more efficiency juice to be squeezed out over the three years since the article was published. (See more data on gasoline prices at the Energy Information Administration.)

A related article on “winners and losers” in the Business Week special report predicted that Starbucks could be among the losers if crude oil prices rose above $100:

As energy gets costlier, those little extravagances in life like, say, a three-buck-a-cup flavored coffee drink could slowly get crowded out. “I think people who drive would stop getting their Starbucks everyday,” Cohan says. “They’d probably make their coffee at home.”

At least in my case, I did make coffee at home this morning. Then later, this afternoon, I drove more than ten miles to get to the Grape + Bean in Old Town Alexandria (Virginia), to pay nearly $2 per 6 oz. cup for coffee, because they have one of these machines. I drove past several Starbucks on the way, so maybe it is bad news for the company.

But I won’t be able to make a regular habit of paying so much for coffee (over $42/gallon!), if gasoline prices continue to be high. Unless, of course, the market starts showing a little more love for energy economists.


8 thoughts on “Foreseeing $105/barrel Oil: a Reason to Love an Economist

  1. The crack spreads have crashed because there is about a 7-year high in gasoline inventory. That’s why pump prices haven’t kept up with crude. Don’t look for that situation to persist for long. Zandi wasn’t fundamentally wrong – if oil stays over $100, we’ll likely get much closer to $4 (we already are in some places.) Also, IIRC Murthi’s forecast said oil would hit $105 by the end of 2005. He was only off by about two and a half years. As it eas, oil peaked at $65 in 2005, or $10 up from the time Murthi issued his forecast.

    Everybody in the finance side of the energy biz knows that Goldman are the most ultra-bullish of the bulls, which is why their forecasts should always be taken with a grain of salt – they seem to like taking the position of providing the upper edge of the envelope, even if they’re never right. And it is true that they like talking up the cost of energy because it benefited the GSCI.

    Predicting is difficult – especially predicting the future. However, inflation means that any forecast of future high prices will likely come true – eventually. At least Murthi did the right thing by applying a time-frame to his wildly erroneous forecast.

  2. The reason that oil can be $110 a barrel yet gasoline is “only” $3.27 a gallon is that US refiners are not making money at this time. Gas is being sold at a loss.

    Now, generally, the January through April timeframe is not a high profit one for most refiners. Demand for gasoline is low. But high prices seem to be exacerbating the drop in demand.

    But when we get into the months where, historically, demand has been higher, watch out. Prices are going to be brutal.

  3. The reason that oil can be $110 a barrel yet gasoline is “only” $3.27 a gallon is that US refiners are not making money at this time. Gas is being sold at a loss.

    Now, generally, the January through April timeframe is not a high profit one for most refiners. Demand for gasoline is low. But high prices seem to be exacerbating the drop in demand.

    But when we get into the months where, historically, demand has been higher, watch out. Prices are going to be brutal.

  4. I never got the 4bucks coffee idea myself. I for one would be fine to see that trend fade. The $100 oil however, we are just beginning to see the ramifications of that. Oddly, I recall growing up in Oklahoma and when oil would fal to say $18 the state economy would crash. I remember people saying that oil needed to be around $30 for the state to do well. Fast forward to now and at $100 a barrel and gas pushing towards $4 a gallon, we are seeing talk of biodiesel for example. Well the problems are this, if we are already going to pay more for everything, including food… and them we start taking soy and corn and turning that into biodiesel then grain prices will just be that much higher. I think we are just in the beginnings here. There is a lot we have yet to see here I am afraid.

  5. I never got the 4bucks coffee idea myself. I for one would be fine to see that trend fade. The $100 oil however, we are just beginning to see the ramifications of that. Oddly, I recall growing up in Oklahoma and when oil would fal to say $18 the state economy would crash. I remember people saying that oil needed to be around $30 for the state to do well. Fast forward to now and at $100 a barrel and gas pushing towards $4 a gallon, we are seeing talk of biodiesel for example. Well the problems are this, if we are already going to pay more for everything, including food… and them we start taking soy and corn and turning that into biodiesel then grain prices will just be that much higher. I think we are just in the beginnings here. There is a lot we have yet to see here I am afraid.

  6. Re: Earthceuticals: I grew up in West Texas and observed a similar boom and bust tied to oil prices. Of course some stability was obtained from cattle, wheat, and cotton prices….

    I wonder how much wheat and cotton land has been turned over to corn for ethanol? (If ethanol prices went high enough, range land will be plowed and irrigated to grow corn if the water can be found. How’s that for ethanol’s contribution to the environment.)

  7. Hey Mike, I think water is the problem for corn. It never rained much in these parts and it seems to be raining less. Also, there’s not alot of topsoil depth in these parts of the country. The dustbowl comes to mind. I like the concept of sustainable energy. Besides the obvious. the plants consume CO2 from the atmosphere equal to the amount they will yiela when the fuel is burnt. That’s the unseen bonus, but I don’t think corn is it. I really, really like the concept out there now of algae being grown for fuel. It is nearly impossible to stop algae growth, all it needs is mainly sunlight and CO2 and a wet medium to grow in. Plus the algae is not a food crop, so raising the prices of grains we need to eat are’t a concern.

  8. Hey Mike, I think water is the problem for corn. It never rained much in these parts and it seems to be raining less. Also, there’s not alot of topsoil depth in these parts of the country. The dustbowl comes to mind. I like the concept of sustainable energy. Besides the obvious. the plants consume CO2 from the atmosphere equal to the amount they will yiela when the fuel is burnt. That’s the unseen bonus, but I don’t think corn is it. I really, really like the concept out there now of algae being grown for fuel. It is nearly impossible to stop algae growth, all it needs is mainly sunlight and CO2 and a wet medium to grow in. Plus the algae is not a food crop, so raising the prices of grains we need to eat are’t a concern.

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