Oil price: Pundits’ forecasts as good as astrologers’ predictions

Over the years, oil pundits have realised that if their prediction on prices turn out to be right, it is by chance and not because of any great insight. It is no different this year, as an analysis of recent forecasts by pundits and different government agencies shows.

To the surprise of all, Brent price has gone north of $60 per barrel this week. Will it continue to go up or fall, and to what level in either direction? What will be the average price of oil in 2021? Current predictions see the price range from $50 to $65. India’s recently announced Budget assumed the higher end.

The US Energy Information Administration (EIA)’s Brent price forecast for 2021 is $53/b, $4 above its earlier forecast. At the beginning of 2020, when no one expected the pandemic, the EIA had predicted that Brent would be $65/b. The actual average price for 2020 turned out to be $41.80/b.

The latest monthly poll of 50 analysts and economists by Reuters shows that Brent is expected to average $54.47/b in 2021. In 2020, a similar poll of analysts had predicted it to be $63.48/b before the pandemic. After the pandemic broke out, it predicted $35.84/b.

Goldman Sachs is bullish on oil and predicting Brent Price to average $65/b in 2021. How good was its forecast for the second quarter of 2020? It had predicted an average price of $20/b, it actually turned out to be $30/b.

These three examples show how predictions of oil pundits based on the sound argument is no better than that any astrologer could make without any expertise.

In 2020, there was an unprecedented and historic drop in petroleum demand due to the ‘black swan’ event of the pandemic. Despite such a major shock to supply/demand, oil price movement has not been impacted, unlike during the previous two oil disruptions when prices skyrocketed.

In 1973, the Organisation of Arab Petroleum Exporting Countries (OAPEC) embargoed mainly the US for its support to Israel during the Yom Kippur war and also cut production. In 1977/78 again, there was oil production disruption in the wake of the Iranian revolution. Oil supply loss during these two disruptions was considerably less than the pandemic-related demand loss by orders of magnitude. Still, contrary to the predictions of most pundits, oil prices recovered in 2020 after falling to a single digit.

According to the International Energy Agency (IEA), the drop in demand for oil was around 8.8 million barrels per day in 2020. Still, Brent price averaged $41.80/b over the year. On April 21 last year, Brent hit a low of $9.12/b while the US benchmark crude closed at minus $38/b at the end of that month. This irrational price movement was only because of the imperfection of the futures market rather than any fundamental supply/demand imbalance.

When we analyse the annual Brent price for the last 10 years, we find two of the lowest prices -- of $43.64 in 2016 and $41.80 in 2020. Unlike in 2020, oil demand was actually rising in 2016. There was one thing in common between these two low oil prices. During these two years, there was an attempt made by one or the other producer to gain a bigger market share -- in 2016, it was Saudi Arabia; in 2020, Russia.

However, in the history of oil, there has never been a crisis like the one in 2020. Besides the dramatic demand drop, the de facto leader of OPEC, Saudi Arabia, and the leader of 10 non-OPEC oil-exporting countries, Russia, had different production strategies. This resulted in a price war for a short period. Russia wanted to maximise production to kill the US shale industry. Saudi Arabia wanted to reduce production to support higher prices. Despite such fundamental differences, thanks to the initiative of Trump, OPEC+ agreed to reduce supplies by 10 mmbd to firm up prices.

With the global roll-out of different vaccines in record time, there is some optimism that oil demand in 2021 will be considerably higher than in 2020. All three major forecasts -- by the IEA, the US EIA and OPEC – say that oil demand will be about 5.5 to 6.0 mmbd above 2020, but below 2019 levels. However, the OPEC+, instead of increasing oil production as agreed earlier by 2 mmbd, decided to increase it by only 0.5 mmbd.

Unless there is some unexpected geopolitical event, there is ample spare capacity to meet any rise in oil demand in 2021. Currently, OPEC+ has the unintended advantage of limited production from sanctions-hit Iran, civil war-hit Venezuela and Libya. This has helped OPEC+ to adhere to production quotas agreed since May last. But one or the other producer can always break discipline and raise production.

The IEA report shows that OPEC needs to produce about 28.4 mmbd to meet the likely demand in 2021. This is 5 mmbd higher than its production in 2020. OPEC has the capacity to produce as much as 34 mmbd. With such a surplus capacity, it is easy to develop a scenario in which oil price can fall. On January 6, the Saudis unilaterally decided to cut production by 1 mmbd for February and March. Such a ‘new year gift’ to fellow OPEC+ members has created a new uncertainty. It has become impossible to guess how far Saudi Arabia will go to support higher prices.

Like during the first quarter of 2020, when OPEC+ failed to agree on a production quota, the current pact may collapse in 2021. Even then, it is unlikely that price will fall below $30/b. This is because as oil price falls below $30/b, at least 4 mmbd of oil capacity with marginal cost higher than $30/b will be shut off and there will be better supply/demand balance. Since shale oil becomes economical to produce when price goes above $50/b, supplies will increase and there will be pressure on the oil price. Thus, the oil price will more than likely range between $45/b and $55/b this year. But don’t bet on it.

(The writer is a former governing council member of Manipal Institute of Technology and an international oil expert)