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IEA sees oil below $80, what could go wrong? Kemp

(John Kemp is a Reuters market analyst. The views expressed are his own)

LONDON – Oil prices are unlikely to rise consistently above $80 per barrel before the end of the decade, the International Energy Agency (IEA) predicted in the World Energy Outlook published on Tuesday.

Slower growth in demand coupled with the transformational impact of shale on production costs and increased supplies from Iran and Iraq will ensure the market rebalances slowly and at lower prices.

The new edition of the World Energy Outlook (WEO 2015) analyzes a range of supply and demand scenarios which see real oil prices rise gradually to between $55 and $83 by 2020.

The problem is there is no evidence that the IEA or anyone else can accurately forecast oil prices five years in future.

In the 2010 WEO, the agency predicted real prices would be around $90 in 2015, and more than $100 in nominal terms, whereas the actual outturn has been around $55.

The forecast went awry because it failed to foresee how the shale revolution, already transforming the natural gas industry, would spread to crude oil production.

WEO 2010 devoted an entire chapter to unconventional oil production but it meant Venezuelan extra heavy oil, Canadian bitumen, oil shale and coal-to-liquids, rather than hydraulic fracturing of light tight oil in the United States, which was largely ignored.

It is fair to ask what could the IEA be missing in WEO 2015?

COMPLEX SYSTEMS

The problem of forecast accuracy is not confined to the energy industry.

In April 2001, five months before the attack on the World Trade Center, U.S. Defense Secretary Donald Rumsfeld forwarded a memo to President George W Bush illustrating how the planning assumptions developed by the military every decade since 1990 had proved wrong.

The memo, featured by Philip Tetlock and Dan Gardner in their recent book on “Superforecasting,” is essential reading for anyone charged with preparing or reviewing predictions about the future (http://bit.ly/1Hub6pX).

Defense policy and the oil market are both complex dynamic systems characterized by lots of non-linearity and destabilizing feedback.

Forecast outcomes in terms of threats and prices are sensitive to small changes in the assumptions made. Even small errors, omissions and unforeseen factors can have a dramatic impact.

Errors compound within the forecast and accuracy deteriorates quickly as the time horizon gets longer (“Complexity: a guided tour” 2009).

In defense policy and the oil market, policymakers demand long-term forecasts because they must make choices about investments that will take a decade or more to deliver and be in service for 20-35 years.

But the demand for long-term forecasts exceeds the ability to supply accurate predictions, as Rumsfeld warned the president.

TO FORECAST, OR NOT

The question is whether it is worth producing long-term predictions at all, given the poor track record of accuracy.

The answer is emphatically Yes. Preparing a forecast compels forecasters and policymakers to think in a rigorous and disciplined way about the variables driving different outcomes.

A comprehensive forecast enables policymakers to see how changing the assumptions and policies results in different outcomes, and identify which assumptions are the most sensitive.

The IEA’s forecasts on prices, production and consumption will almost certainly prove wrong, as they have been in the past. But the report’s value lies in its contextual analysis and asking how the assumptions might be challenged.

The World Energy Outlook contains a wealth of detail examining how supply and demand are sensitive to assumptions about policies on fuel efficiency and climate change, as well as the condition of the world economy, global population growth and oil production from different technologies and geographies.

Readers are advised to ignore the price predictions and concentrate on the rest of the report, which is much more useful and contains some of the finest analysis in the market.

Kemp: Volatility and flash events in the oil market.

(Editing by Susan Thomas)

This article was from Reuters and was legally licensed through the NewsCred publisher network.