For two weeks, news reports have predicted
off-the-cliff falls in the global price of crude oil on the spot market, based
on publicized forecasts. What the
newspapers don’t note is that many forecasts are based simply on past
data. They assume that any new data
trends will continue, regardless of the reasons (if any) for those trends.
And rarely do the newspapers report anything more than the point forecast (say, $55); they ignore the range of likely prices (e.g., $30 to $80 – the “confidence interval”) which is especially large for long-run forecasts. By itself, the point estimate is not of much use because it is rarely exactly correct. The question then becomes: What values near the point estimate may well occur? To answer that, we need the confidence interval.
Finally, most news reports are based on authority, not logic. In their view, Organization X's forecast is important because X is important, not because its forecast is well-grounded.
And rarely do the newspapers report anything more than the point forecast (say, $55); they ignore the range of likely prices (e.g., $30 to $80 – the “confidence interval”) which is especially large for long-run forecasts. By itself, the point estimate is not of much use because it is rarely exactly correct. The question then becomes: What values near the point estimate may well occur? To answer that, we need the confidence interval.
Finally, most news reports are based on authority, not logic. In their view, Organization X's forecast is important because X is important, not because its forecast is well-grounded.
Let’s go back to basics. The long-run price of any product is an
adjustment to market changes. The price
of X will fall if otherwise the market would remain in excess supply. In particular, the long-run global price of
crude oil will fall if either supply has increased or demand has decreased,
recently and permanently. The problem is
to determine what might have precipitated either event. The reason for the last price collapse, in
2009, was clearly global recession. What
reasons stand out today?
Supply. World oil output is rising
but not dramatically. It increased by
1.7% from 2013 to 2014 for the period January through August, the latest data
available from the United States Energy Information Administration. It is not realistic to think that a 1.7%
increase in supply can lead to a 30% or 40% decrease in price.
Demand. The Chinese and European
economies have slowed, but those trends are not new. The Chinese growth rate has been relatively soft
for two or three years, according to World Bank data. The European economy has been sagging for at
least five years.
K-traders
The problem is to explain why short-term
oil prices have fallen 30% since June. The only apparent new event of the past few
months has been the tightening sanctions against Russia
Another possibility is that oil contracts
take time to rewrite, so the recent price decline reflects market conditions of
the past year or two. But since various
contracts come up for renewal at various times, this might not explain the
suddenness of the price decline.
Finally, some news reports suggest that
prices have fallen because of a confluence of random factors. In that case, the factors, being random, will
disappear. They should not affect
long-run prices.
So, why have crude prices fallen so
abruptly? One reason may be
speculation. Many traders believe that
the market price is determined not by supply and demand but by the average
beliefs of traders. I will call them
“Keynesian” traders, because John Maynard Keynes analyzed this strategy in 1936,
in his General theory of employment,
interest and money.
Keynesian traders regard an initial fall in
price, which may occur randomly, as evidence that other traders believe that
prices will continue to fall; so they sell the product short. The short sales themselves reduce prices on
the futures market, making the Keynesian strategy a self-fulfilling prophecy. This may help explain the disproportionate fall in oil prices two weeks ago in response to OPEC's decision not to reduce output.
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