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Why Are Oil Prices So Hard To Forecast?

News Article by Inplex Custom Extruders, LLC


Why Are Oil Prices So Hard To Forecast?

For the oil forecasting community, the most recent collapse in oil prices marks one more failure. The long trail of forecast errors includes the market implosions of 1982 and 1986, not seeing the run-up in commodity prices after 2004 and now missing the end of the same commodity boom. For those of us who depend on oil price forecasts, this is a big problem.

Try to forecast the economic outlook for Houston or the Gulf Coast, for example, without a good handle on oil prices. Right now, I am coping with oil price uncertainty by preparing several scenarios for Houston’s economic outlook, mostly conditioned by guessing when and how fast oil prices might recover.


The process took me through a number of current oil price forecasts from banks, investment houses and consultants, and the differences in opinion are wide and discouraging. I was left asking: Why is it so hard to forecast oil prices?

Oil Futures as a Spot Price Forecast     

This latest forecasting led me to the crude oil futures market, an often-quoted and much-maligned forecast of oil prices. In principle, it should be a very good predictor. But in fact, using the futures price as a forecast of the spot price of oil is a very small improvement over predicting that oil prices will be the same tomorrow as they are today. That sounds terrible, until you learn that futures market predictions beat all the alternatives, including other financial models, statistical models and expert surveys. Why can’t we do better?


Figure 1 shows prices on the futures strip for NYMEX crude oil on December 31, 2015. At each date, the price is the payment that would be made and received for a barrel of West Texas Intermediate (WTI) delivered at that time. In the 1930s, it was thought that the spot or current price and all futures prices were independent, each determined by economic fundamentals prevailing at that point in time.

In the 1940s, agricultural economist Holbrook Working showed that spot and futures prices were closely linked by the cost of storage. If the 12-month futures price was higher than the spot price plus the cost of 12 months of storage, for example, I should buy inventory today, store it and sell it at a profit later. By the 1970s, economists had worked out how producers, consumers, hedgers and speculators take a history of past prices, inventories and market fundamentals, arbitrage across time, and the market simultaneously solves for the spot price and futures prices.