Oil price outlook

(Nov.20, 2017)

The chart shows the prices of crude oil at which buyers and sellers on the New York Mercantile Exchange have agreed to buy/sell oil at some point in the future. These are the so-called futures contracts and reflect the expectations of market participants. The buyers and sellers have agreed now at what price to trade oil in the future. Therefore, with some caveats outlined below, we can assume that the futures prices reflect to a large extent their expectations of the future oil prices.

These expectations may not come true but they are probably the best available forecast numbers. They aggregate the knowledge of buyers and sellers who try really hard to stay informed about oil prices. Other forecasting methods based on survey data or macroeconomic analysis do not seem to perform better. So, what do these futures prices tell us? The market participants expect the current crude oil price of 62 USD per barrel to decrease to 60 USD per barrel in November 2018.

Please feel free to contact us with any questions about these outlook numbers. You may also like to see what the oil price forecast implies about the future retail fuel prices.

Some caveats on the futures prices as predictors

In addition to the expected price of oil, futures prices also contain the risk premium and the so-called convenience yield:

Futures price of oil = Expected price of oil + Risk Premium + Convenience Yield

The risk premium reflects the desire of buyers and sellers to avoid uncertainty about the price at which they can buy or sell oil in the future. To reduce the uncertainty, buyers may be willing to pay a premium over what they think the future price of oil would actually be. Similarly, to assure a market for their oil, sellers may be willing to accept less than the expected future oil price. Depending on which side of the market feels a greater need for insurance, the risk premium could be positive or negative. It could also vary over time as market conditions change.

The convenience yield reflects oil refiners’ desire to have stocks of oil in order to ensure a smooth production process. Maintaining an optimal stock of oil requires a decision to buy oil now and to plan to buy oil in the future. The decision is affected by the current demand and supply for oil as well as the expected future demand and supply. Therefore, as market conditions change, the convenience yield also changes.

We cannot directly observe the risk premium or the convenience yield and, also, they probably change over time. Therefore, the futures price of oil is not exactly equal to the expected price of oil. However, despite these caveats, the futures price of oil seems to be as good (or as bad) of a predictor of oil prices as the alternatives: surveys of expert forecasters and fundamentals models based on macroeconomic data. The advantage of the futures price data is that they are transparent and continuously updated as the market incorporates new information about the oil market and the global economy overall. Nonetheless, the best course of action is to look at the futures data but also to stay informed of the fundamentals moving the supply and demand for oil.

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