Goldman Sachs' Cloudy Crystal Ball Oil Price Forecast
Goldman Sachs’ analysis that the price of crude oil could perhaps fall to $20 a barrel is no better than its prior predictions. This is the same Goldman Sachs that in 2008 predicted that the price of oil was going to reach $200 a barrel.
The $20 forecast, made September 11, caused financial network talking heads to spend a lot of air-time discussing the analysis and giving various rationalizations to explain why it would or would not happen. Some were even talking about the return of gasoline prices below $2 a gallon. The amount of air-time given to the Goldman Sachs analysis gave it a level of credibility that was independent of its quality. As a result, it caused more downward pressure on Friday’s crude price, which was a boon to some traders.
The history of oil price predictions is one of a few lucky guesses and a lot of failed ones. The reason is that global oil and economic markets are too complex for even the most knowledgeable experts to accurately capture all of the relevant variables that determine price changes. Less than 20 years ago, when the price of crude plunged to about $10 a barrel, there were predictions of “low oil prices as far as the eye could see.” By 2005, the price was $61 and rising. Those experts were obviously near sighted.
Some forecasters always predict either rising or falling prices, according to Michael Lynch, a well-respected petroleum economist. He observed that this is known as the “stopped watch approach to forecasting: constantly make one prediction and eventually the market will move in that direction. Especially for oil prices, which are highly variable, this works wonders to the point where the great Adam Sieminski often joked that you should predict the price or the date, but not both”.
Last year, Wall Street Journal reporter Ben Casselman wrote: “It isn’t surprising that experts aren’t good at predicting prices. Global oil markets are a function of countless variables — geopolitics, economics, technology, geology — each with its own inherent uncertainty. And even if you get those estimates right, you never know when a war in the Middle East or an oil boom in North Dakota will suddenly turn the whole formula on its head”. No one mentioned these variables in promoting the Goldman Sachs analysis.
The prediction that oil could hit $20 is driven primarily by an assumption of oversupply and shrinking storage capacity. If those were the only two variables that mattered, the prediction might be plausible. However, as Casselman noted, there are other variables that have to be taken into consideration.
If producers believe that prices will stay low and their cost of production is higher than their revenue estimate, they will cut back. If the cost of renting tanker storage is less than the cost of shutting in production, they will rent tanker space. With gasoline prices dropping, people are willing to drive more and indeed the mix of new light duty vehicle sales is shifting to larger, lower mileage vehicles no one knows how much this will increase demand. No one knows whether the Saudis will continue their production level, or how much tight oil from fracking will continue to be produced.
Economic forecasts, which affect the demand for oil products, are notoriously poor. Weak price forecasts are based in part on assumptions of continued global economic weakness, especially in China. If those forecasts underestimate 2016 economic growth, demand will grow and as it does so will the price of crude.
Whether one looks back five years ten years or longer, the history of oil prices is one of substantial volatility. No one has found a good model for estimating volatility and without that, predictions are as much guesses as robust analysis. The media would serve its listeners and readers well by taking forecasts like Goldman Sachs with a grain of salt, putting them in the context of history and uncertainty, and pointing out how they benefit traders, such as those who work for Goldman Sachs.
William O'Keefe is CEO of the George C. Marshall Institute. You can follow him on Twitter here.
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