2008 Crude Oil Prices

Wednesday, October 14, 2009

This is the time when people want to know what oil prices will be in the coming year.

As a 40+year veteran of the oil price forecasting wars, there a couple of caveats that need to be presented. First, oil price forecasting is a fundamental budgeting requirement for energy producers and consumers. Second, no matter how clever, insightful and lucky you are your forecast will be wrong.

The U.S. Energy Information Administration in their updated Short-Term Energy Outlook released January 8, 2008, projects West Texas Intermediate “prices to average about $87 and $82 per barrel, respectively, in 2008 and 2009.”

The Energy Information Administration (EIA) has been preparing price forecasts since 1982 and the percent error has ranged from a low of 22.3% (2003 forecast) to a high of 126.3% (1998 forecast). The forecast error has averaged 53.7%. (See Annual Energy Outlook Retrospective Review) This is not a criticism of the EIA analysts, but rather a reality check on all oil price forecasts.

I am certainly not going to tell you that my batting average is any better. If it was I would be spending my day poolside in some Caribbean paradise. Anyone who tells you that they have a track record of producing highly accurate forecasts is probably looking to sell you a subscription. I would avoid these sources unless you have a weak spot for sports forecasting services.

So given the inherent problems of price forecasting what should you do? The need for forecasts cited above requires you to have a credible and acceptable projection. Down at the ranch we would describe this as a “CYA” number. People are committing a lot of money based on what you say, so you better have a lot of company in your forecast. Using published and/or your banker’s forecasts are generally desirable. When the cost or revenue projections are wrong you’ve got some basis (excuses) for the error.

Another issue here is your perspective. If you are a consumer and trying to manage fuel costs, being on the high side has merit. If you are a producer and estimating future earnings, low side projections are called for. Another approach is to use a range of forecasts. This allows you to consider the consequences of lower and higher than prices. Analysts must use care in developing the price range to avoid unrealistic extremes.

We’d like to hear your thoughts on 2008 prices and pricing methodology and philosophy.

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