Oil price forecast and outlook

You need a forecast of crude oil prices. Where do you look? Our suggestion is to start with the U.S. Energy Information Administration forecast numbers, then check if those seem consistent with the NYMEX futures prices, do a media search on forecasts from investment banks and others, and skim through the International Energy Agency monthly report summary. This takes about an hour and can be done once per month. Here is more detail:

1. The short-term energy outlook of the U.S. Energy Information Administration comes out around the 10th of each month and has forecasts for Brent and WTI for the current and the next year. The charts also show a "95 percent confidence interval" for the future oil prices, i.e. a range where prices may fall in the future and it is a recognition that oil prices are quite unpredictable. That range is extracted from the options market where traders take positions to hedge various bets. The outlook also has a concise narrative that summarizes the various current supply and demand influences on the oil market.

That source is about as reliable as any other and is consistent in terms of the timing of releases and format. If you read these releases on a monthly basis, you will be well informed of trends in the oil market and the current thinking about the trajectory of future prices. The U.S. EIA also publish an annual long-term energy outlook with predictions stretching forward a few decades. These documents give a broader framework for thinking about oil.

2. The futures prices at the New York Mercantile Exchange (the current futures prices are here: Brent and WTI) are also useful to look at. These are the prices at which buyers and sellers on the NYMEX 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 readily-available forecast numbers. They aggregate the knowledge of buyers and sellers who try hard to stay informed about oil prices.

Important caveats: 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. That 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. Also, they provide monthly future price points if one needs a higher frequency outlook.

3. Investment banks routinely publish oil price predictions with commentary. These forecasts do not come out on a regular schedule but can be easily found by doing a google news search for "oil price forecast". If Bank of America, Goldman Sachs, Merrill Lynch or some of the other big investment companies has issued a forecast, it would be immediately visible on the google results. The Wall Street Journal, Bloomberg and other news outlets often run surveys of forecasters. Some governments with high oil production as well as the oil majors such as Exxon, BP, and Shell also issue forecasts. All of those would show on the google news search.

The idea of the media search is to get a feeling of the current thinking of oil prices among various institutions. You do not get one number that can be plugged into a forecasting model but a sense of the range of forecasts, the degree of uncertainty and consensus. You can also determine if the U.S. EIA forecasts and the NYMEX futures prices are in line with the broader market discourse.

4. Last, but not least, are the regular monthly research releases by the International Energy Agency. That is the premiere global institution on these matters and their monthly oil market report is a must-read for people in this field. The summary of the report is probably enough as a reading material on a regular basis but one can also dive deeper into the full report. Similar to the narrative of the U.S. EIA monthly outlook releases, the report provides supply and demand information and it very useful to stay informed of which way things in the oil market are headed. One drawback, however, is that the EIA does not give a point estimate of the future expected oil prices.

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