Michael Giberson
Today a Washington Post article discusses the most recent oil price forecast from Goldman Sachs analysts Arjun N. Murti and Jeffrey Currie, which have oil prices averaging $141/bbl for the second half of 2008. As usual, it isn’t hard to find an analyst with a contrary view, and the article presents some counter arguments. (One observer notes that even with GS’s prediction of a oil price between $150 and $200 in the next several months, the company merely rates Exxon Mobil as “neutral.” Suggested is that even within the firm, not all persons are believers.)
The article notes Murti’s track record for newsmaking high price forecasts which subsequently are reached, and presents a somewhat selective graphic in support. How good is Murti’s record? The text explains that the famous $50-$105 prediction from March 2005 was directed at the next 6 to 24 months. (Discussed here in March 2008 as “Foreseeing $105/barrel oil“) Price swung up to about $78, then down, and two years after Murti’s prediction – in March of 2007 – prices were about the same level as March 2005: near $60/bbl. Of course, prices did mostly stay within the predicted range and some contemporary predictions had prices falling to $30, $20 or lower. Probably safe to say that Murti’s risky forecast turned out to be better than most.
GS’s Currie gives the short-hand version for the most recent forecasts:
“World GDP wants to grow at 3.8 percent, whereas the best we can come up with for trend supply growth is 1 percent,” he said. “So something has to give. And that means prices have to rise to curtail demand growth.”
Perhaps you’d like something more systematic than a newspaper account? For you, then, is James Hamilton’s “Understanding crude oil prices” (title links to abstract, here is a direct link to the article).
Hamilton employs three different approaches to assessing crude oil prices. First, he takes a fairly basic look at statistical correlations in time series analysis. Second, he examines the lessons from economic theory. Third, he examines various fundamental conditions affecting supply and demand for oil.
One thing looking at the time series data tells you is that the current price tends to be the best predictor of the price a quarter from now (“the real price of oil seems to follow a random walk without drift”), but the variance is wide (beginning at a price of $115, it would not be surprising based on historical price movements for prices a quarter from now to be as high as $156 or as low as $85).
In his economic theory discussion he considers storage arbitrage effects, possible effects of financial market trading, and effects expected given that oil is a depletable resource. In the fundamentals discussion, Hamilton considers the role of the OPEC cartel, the changing elasticity of supply and demand, and whether oil markets may now be figuring in a scarcity rent (implied by Hotelling’s model of a depletable resource).
He concludes “the low price-elasticity of short-run demand and supply, the vulnerability of supplies to disruptions, and the peak in U.S. oil production account for the broad behavior of oil prices over 1970-1997.” As for the period after 1997, he tentatively concludes, “the profound change in demand coming from the newly industrialized countries and recognition of the finiteness of this resource offers a plausible explanation for more recent developments. In other words, the scarcity rent may have been negligible for previous generations but is now becoming significant.”
Reader John Mashey, in a comment on my post “Are oil prices too high?“, wonders whether we are at an inflection point (i.e. a fundamental change in the relationship between oil prices and the world economy). Hamilton seems to suggest that the inflection point was 1997/1998.
In my mind the interesting issue concerning the relatively tepid supply response to historically high oil prices concerns whether we are becoming short of producible oil resources, or just short of the tools to produce more oil resources with. My view remains the same as it was the other day, when discussing that confused New York Times article:
The world is running out of oil production capacity because there is a global dash for oil. This dash is the oil supply response, and it is probably not too soon to conclude the world oil production will be higher this year than last, even as we are short on oil production capacity.
Hamilton’s piece didn’t quite disrupt this view, but I am becoming more open to the possibility. I think additional careful look at world oil supply would be helpful.
The only thing I remember about oil prices in ’97 was their collapse after the Asian financial crisis. I find the choice of that date for an inflection point to a higher price level to be puzzling.
’04 makes a lot more sense to me. Maybe the leading edge trended higher a year or two earlier.
Being in the refining equipment business, the years ’97 to ’03 were just brutal.
The only thing I remember about oil prices in ’97 was their collapse after the Asian financial crisis. I find the choice of that date for an inflection point to a higher price level to be puzzling.
’04 makes a lot more sense to me. Maybe the leading edge trended higher a year or two earlier.
Being in the refining equipment business, the years ’97 to ’03 were just brutal.
Not being in the oil buisiness, this is very confusing. from what I understand oil as a global commodity is no loger based on the U.S. dollar. When compared to other commodities ie; gold, it really hasnt risen much. The dollars falling value being the main cause of inflation. If we licence companies to drill in Anwar, or anywhere in the U.S., will this really lower costs? or will they just continue to sell to the highest bidder? It seems to me that a dollar is still only worth a dollar, we would have to practicaly flood the world with oil to lower our costs now.
I certainly think new oilfields will be found … but:
a) During the 1990s, I helped design supercomputers and probably helped sell $500M of them to oil companies around the world. [I was Chief Scientist at Silicon Graphics.] In practice, that meant:
Doing all-day visits with petroleum geologists, computing people, and executives around the world. The reason they had me out there was not just to give a sales pitch for computers, but to have in-depth discussions with them about their problems, what they needed to do, what they wanted to do, whether our systems could do what they wanted, or if not now, then when.
They used our systems for seismic analysis, i.e., figuring out where the oil was, and reservoir modeling, i.e., to figure out how to manage the reservoir flows to extract oil most cost-effectively, and large-screen 3D visualization for fly-throughs. There was a huge leap in relevant computing technology in the 1990s, and they needed it … just to stay even. Many petroleum geologists were proud of their newer techniques, since it was no longer a case of sticking a pipe in the ground and seeing the gusher. I.e., the easy oil had been found.
When I read Ken Deffeyes’ “Beyond Oil” or Matt Simmons’ “Twilight in the Desert” or David Strahan’s “The Last Oil Shock”, they accord well with what I heard for years.
b) One long-time friend of ours is Lord Ron Oxburgh, ex-Chairman of Shell in UK. He is very blunt about the realities of Peak Oil. Another friend is Dennis Bonney, ex-Vice-Chairman of Chevron, who has similar thoughts.
c) If you read the commentary on James Hamilton’s article, perhaps you might take a look at the questions I posted May 25, 2008 7:11pm, and JDH’s kind reply May 26, 2008 12:20pm. Any comments?
d) The reason I’m sensitive to inflection points is that I spent decades in the computer business, where it was corporate life-and-death to correctly project trendlines and their ratios, and do it every year, because changes came fast. Needless to say, log-scale charts were very useful, given that constant growth rates were straight lines. However, doing straight-line projections from historical records often totally missed impending inflections caused by real physical limits.
I certainly think new oilfields will be found … but:
a) During the 1990s, I helped design supercomputers and probably helped sell $500M of them to oil companies around the world. [I was Chief Scientist at Silicon Graphics.] In practice, that meant:
Doing all-day visits with petroleum geologists, computing people, and executives around the world. The reason they had me out there was not just to give a sales pitch for computers, but to have in-depth discussions with them about their problems, what they needed to do, what they wanted to do, whether our systems could do what they wanted, or if not now, then when.
They used our systems for seismic analysis, i.e., figuring out where the oil was, and reservoir modeling, i.e., to figure out how to manage the reservoir flows to extract oil most cost-effectively, and large-screen 3D visualization for fly-throughs. There was a huge leap in relevant computing technology in the 1990s, and they needed it … just to stay even. Many petroleum geologists were proud of their newer techniques, since it was no longer a case of sticking a pipe in the ground and seeing the gusher. I.e., the easy oil had been found.
When I read Ken Deffeyes’ “Beyond Oil” or Matt Simmons’ “Twilight in the Desert” or David Strahan’s “The Last Oil Shock”, they accord well with what I heard for years.
b) One long-time friend of ours is Lord Ron Oxburgh, ex-Chairman of Shell in UK. He is very blunt about the realities of Peak Oil. Another friend is Dennis Bonney, ex-Vice-Chairman of Chevron, who has similar thoughts.
c) If you read the commentary on James Hamilton’s article, perhaps you might take a look at the questions I posted May 25, 2008 7:11pm, and JDH’s kind reply May 26, 2008 12:20pm. Any comments?
d) The reason I’m sensitive to inflection points is that I spent decades in the computer business, where it was corporate life-and-death to correctly project trendlines and their ratios, and do it every year, because changes came fast. Needless to say, log-scale charts were very useful, given that constant growth rates were straight lines. However, doing straight-line projections from historical records often totally missed impending inflections caused by real physical limits.
pure speculation i think, but speculators are about to lose all of their money, due to rising of instability in several countries due to oil prices, i think soon oil price will fall to about 70 dollars