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.