The debate over future oil prices
WHY FORECASTERS ALMOST ALWAYS GET IT WRONG AND
WHY NOBODY LISTENS WHEN THEY GET IT RIGHT
CHARLES CHERINGTON, ARGUS ENERGY MANAGERS, HOUSTON
NOTHING IS MORE AMUSING than watching oil industry
forecasters, the legions of pilot fish attached to the great industry whale. The number of these fish dedicated solely to
predicting the whale’s future direction is in the high thousands.
Market forecasters work at contract research firms, investment
and commercial banks, hedge funds, oil midstream and downstream enterprises, power companies, airlines, energy private
equity firms, and government agencies, just to name a few.
All forecasters share a common trait: they are wrong. Some
are only wrong most of the time and most are wrong all the
time. While other industry whales also support vast populations of wrong-headed pilot fish (stock market, anyone?),
nothing compares to the oil and gas sector. One day, an enterprising PhD student will collect all the past forecasts of the
wise and the worthy and carefully document their spectacular
legacy of wrongness. Even then, the forecasting ecosystem
will continue to thrive, undaunted.
Why is the market so unknowable, and why do we keep
The forecasters persist in casting bones, reading tea leaves,
and firing up their hard drives because they are paid good
money. Forecast consumers are inherently gullible. It is a
strange world in which willing consumers consume products
defined principally by their persistent wrongness.
But what question is it that forecasters try to answer? If
you took the weight of all the papers written about the short-term market—what will happen in the next year or two—you
would fill several large dumpsters. Work devoted to the long-term market? Perhaps a single trash can. Yet, the short-term
market’s noise generally overwhelms its faint signal, whereas
the long-term market actually reverses that equation at certain
points in the cycle. However, forecasters give the people what
they want, which tends to focus on tomorrow or next month.
After all, what happens tomorrow drives most trading and
stock prices. Ask today’s oilfield service company CEO about
prices in five years, and he’ll have to restrain himself from
socking you. His chief preoccupation is making payroll next
There’s another reason people keep buying what the sooth-
sayers sell. Occasionally, they are right. Once in a while, clear
signals emerge from the noise, and when they do, they can be
extremely valuable. But in a world of overwhelming noise,
how do you know when you are hearing a signal? In 2014, oil
inventory was bloated and getting worse. Daily supply was
greater than demand, with no end in sight. But few market
players seemed to hear the signal, even though it was deafening.
That’s because when the soothsayers are wrong so much of
the time, when they start yelling about a pack of wolves at the
village gate, very few people listen. It is also because the market
was convinced that the long upcycle would continue, as if by
magic. Even when OPEC elected not to cut production in late
2014, market sages ignored the deafening signal and blithely
declared that the downturn would be short-lived.
SHORT-TERM VERSUS LONG-TERM MARKETS
Short-term markets have, in recent years, gone from merely
unpredictable to completely crazy. Several factors have
The volume of oil derivatives has grown to 15x the quantity
of the physical commodity being produced. Derivatives are
either ignored or misunderstood by much of the market. Even
for those who try to include derivatives in their analysis of
near-term behavior have to contend with market opacity.
Imagine trying to predict the driving performance of a Mini
Cooper on a highway. Unbeknownst to you, it is attached by
a short chain to 15 invisible Harley soft tails also moving down
the highway. Good luck.
Short-run oil pricing behavior is heavily influenced by
players reacting to single factors like an OPEC announcement.
Two distortions tend to arise: first those factors don’t tend to
be clearly understood, and second, they tend to be over weighted. How much ink has been spilled in the last two years, both
in exuberance and despair, in response to OPEC announcements? A great deal.
Shale. In one sense, shale isn’t a big deal. Five million barrels
of daily supply in a 97 million barrel market isn’t much. However, the global oil market can be thought of as an ecosystem.
The river of supply (Supply River) enters the North end of a
lake of inventory (Lake Inventory) and exits the south end
through a river of demand (Demand River). When Supply
River pours more into Lake Inventory than Demand River
drains on the other end, the Lake grows. In 2012-2013, the
lake held about 4. 8-4. 9 billion barrels, or 50 days of supply. By
the first quarter of 2015, it had grown to 5. 4 billion barrels.
Why did an additional four days of supply eventually cause
the market to crash and launch one of the longest, most severe
downturns in history? Shale turned the industry—and the
Imagine that someone waves a magic wand and adds a
five-million-barrel-per-day tributary to Supply River (Shale
Tributary). That’s shale. It threw the whole global system out
of balance. Without shale, Lake Inventory would be running
dry, and prices would be over $100 per barrel. With shale, the
market is oversupplied, the Lake is overflowing its banks, and