We Can’t Predict the Future of Oil and Gas Prices by Jeff D. Opdyke, The Sovereign Investor

In 2003, The Mirage, one of the premiere casino hotels in Vegas, lost an estimated $100 million and 10,000 visitors a week when a hand-raised tiger bit and grievously injured Roy Horn, half of Siegfried & Roy.

That bite — which no executive or show producer ever expected — ended the run of one of Vegas’ richest and most-important headline acts.

And they had no way to see it coming.

Every year, the Energy Information Administration (EIA) — the U.S. government’s official arbiter and prognosticator for all things energy — releases various reports that look at factors driving the oil and gas market. It throws all the data into whatever statistical numbers grinder it uses and produces projections for global energy production, consumption and prices five to 20 years out.

They assume that whatever sort of predictions they can make today will be at all statistically relevant that far in the future.

Now, let’s all agree that no one can predict tomorrow, much less a tomorrow that we won’t see for another 9,000 or so sunrises. But we’re going to assume we can predict the future of oil and gas prices that far ahead, because there’s a useful moral that comes out of it.

The EIA’s International Energy Outlook 2014, which arrived in September and which Forbes used over the weekend to mock the “Peak Oil” theory, projects that global energy production will rise to the equivalent of 119.4 million barrels a day from roughly 90 million barrels today. Much of that growth will, in theory, come from the U.S. and all the shale oil and gas we have underneath our land (and that’s assuming the estimates of probable reserves are not overstated, as experts are beginning to suspect).

That jump in production is coming even as other organizations talk about declining demand because of a weak global economy, conservation efforts, a move toward green power, yada yada yada.

All of that is helping push oil prices to a level that even OPEC ministers who want a (temporarily) low price are now saying do not reflect current supply/demand realities.

So, with that in mind, I went back in time to retrieve previous EIA estimates and see how those have fared and changed through the years. The look-back is telling for those who are today basing investment decisions on current predictions…

Stuck in Normalcy

Just to give you some context for how far theyHere’s what the EIA had to say in 1990:

  • Global oil consumption by 2010 reaches, at most, 65 million barrels a day.
  • Oil prices rise between 2% and 5% annually over the forecast [out to 2010].
  • By the late 1990s, as production from all non-OPEC sources declines, the market share for OPEC will steadily increase … the net result will be increasingly concentrated production capacity within a small group of producers, particularly the Persian Gulf “core” producers of Saudi Arabia, Iran, Iraq, Kuwait and the United Arab Emirates.
  • Much of the growth in oil consumption is projected to occur in the United States.
  • OPEC production by 2010 will be as much as 61% of total global production.
  • Non-OPEC production will reach, at most, 25.6 million barrels a day.

So, how well did the EIA fare in reading its crystal ball?

  • Global oil consumption in 2010 was 87.8 million barrels a day, not 65 million.
  • Oil prices between 1990 and 2010 grew at a rate of more 9% a year, nearly double the EIA’s highest expectation of 5%.
  • The OPEC “core” saw its market share increase to 27% of daily production from 24%; not much of an “increasingly concentrated production capacity.”
  • U.S. oil consumption by 2010 had grown at an average annual rate of just 0.6%. Brazil’s consumption grew by more than 3% annually. China’s grew by nearly 12%. India grew by 4%. In fact, almost every non-developed country consumed oil at a dramatically faster pace than America. And though we consume more barrels than anyone else, China’s daily consumption outstripped us by a factor of three. India nearly matched us … and Saudi Arabia wasn’t far behind.
  • OPEC controlled just 42% of world production instead of the projected 61%, while non-OPEC countries controlled 58%.
  • Daily, non-OPEC rose to nearly 52 million barrels, double EIA projections.

Clearly, the EIA missed the mark dramatically.

When I look at other specific years, like 1985 (amid an oil-price crash), 2000 (as the new millennium began) and 2007 (before the global financial crisis hit), it’s clear that EIA’s crystal-ball gazers generally suffer from the same biases that plague the rest of society. Their projections tend to reflect the normalcy of the moment. They largely project a continuation of the status quo … because, like all of us, even the experts don’t know to expect the tiger bites that represent the unseen risks.

Prepare for the Unexpected

EIA forecasters in the spring of 1990 had no way to project the Iraq war later that year.

They could not project the 2001 terrorist attacks that would give rise to the lies and deceits the Bush/Cheney administration would use to go back into Iraq in 2003 — lies and deceits that have effectively screwed up certain oil producing countries and given rise to an even more-virulent band of militants/terrorists that are a larger threat to global oil than Al Qaeda ever was.

They could not predict the moon-shot in commodities prices that lead to a massive oil spike in 2008, or the rise of the shale-oil production boom in the U.S., or the rise of the Arab Spring.

They had no way to envision the European debt crisis or a quasi-war in the Ukraine that has led to sanctions on a major oil nation, Russia, and pinched demand in a major consuming region, Western Europe.

All of those have had various types of impacts on oil supply and demand … and prices.

I’m not faulting the EIA. No one could have predicted that particular stream of events. But, of course, that means no one — including the EIA — can predict the exact stream of events that are coming.

Which leads us to today’s moral: We cannot know what we do not know … which means we cannot base investment decisions on long-range projections, because those projections assume a normalcy that simply does not exist.

What we can do, is look at the cards we have before us and make our best guess.

Logically, it’s easy to see that energy demand must rise because of the rising middle class in the developing world. Logically, it’s easy to see that many oil-producing nations need higher oil prices to maintain social spending priorities domestically or risk a citizen-led coup like those that toppled governments in Tunisia and Egypt. Logically, it’s easy to see that U.S. production tops out in just a few years, and that U.S. shale production is not very cheap.

When you consider these variables, it’s easy to see that oil prices ultimately go higher, because lower prices lead to unemployment in America’s oil patch, social instability in the developing-economy oil nations, and declining production in non-OPEC nations that cannot produce oil at relatively cheap prices.

How we get to that future, we have no way

1, 2  - View Full Page