What will the price of crude oil be in the coming year? The Wall Street Journal notes that prognosticators are now betting on the high side after incorrectly lowballing estimates for the past few years. One of the interesting indicators noted in the article is the use of Saudi Arabian benchmarks for the price of oil while making government budget forecasts. Usually, the Saudi government conservatively estimates the price of oil. Like many Middle East petrostates, Saudi Arabia does not collect income taxes; 90% of its revenues are from the black stuff. Hence, there is a strong incentive for the country to come up with accurate estimates. Adding a customary 30% to the conservative Saudi figure and you come up with about $75 a barrel for benchmark light sweet crude. While this figure comes in below most pundits' estimates, I would take it seriously with the US economy downshifting and all. Again, it goes back somewhat to just how much the rest of the world will "decouple" from the US; the pundits seem to say "not much, if at all":Oil-price prognosticators, bruised after an unusually volatile spell in the oil patch, have reached a rough consensus on next year: Oil will be even costlier, even if the economy cools. Consumers are likely to pay a lot more at the pump, too. The Energy Department predicts that far higher average oil prices will force gasoline prices to even out at $3.11 next year, up 10% from the average price of $2.81 this year.
World crude prices have long tracked the thirst for oil in the U.S., which consumes about a quarter of the world's oil output. But recent months have shown how decoupled the oil market is becoming from the economic ups and downs of the world's largest energy consumer. Even amid fears that the U.S. could slip into recession next year, world-wide consumption is expected to strengthen, driven mostly by more demand from Asia as well as from Middle Eastern economies awash in oil revenue. That, of course, will further tighten global supplies.
Forecasters are notching other lessons from 2007 in looking toward next year. One is that the almost irrational uncertainty that sent prices soaring to more than $98 in November from $69 in late August will last well into 2008. "If I had to describe [2007] in one image, it would be dancing on thin ice," says Fatih Birol, chief economist at the International Energy Agency, which serves as an energy watchdog for rich countries. Global spare capacity is so thin, he says, "that any little thing now can influence price."
A year ago, almost no one in the oil business -- from producers and Energy Department analysts to Wall Street traders -- foresaw crude prices careening toward $100 a barrel this year. Some big investment houses, Morgan Stanley foremost among them, even predicted prices would fall. Instead, prices went on an unprecedented roller-coaster ride, rising to a nominal record of $98.18 last month from the low of roughly $50 a barrel in mid-January. Most of the industry's leading lights now are predicting the U.S. benchmark crude, as traded on the New York Mercantile Exchange, will average around $80 a barrel next year, up from $71.89 this year. The benchmark Friday closed at $93.31.
Extrapolating from forecasts underlying Saudi Arabia's own budget-revenue projections for next year, economists say Saudi Arabia, the world's largest oil producer, expects U.S. benchmark crude to average around $75 a barrel next year. Forecasters at Lehman Brothers Holdings Inc., who predict an average price of $84 a barrel, cite the market's own increasing opacity as one reason why prices will stay bullish.
Big producers from the Organization of Petroleum Exporting Countries are expected to gain an ever-larger share of the market next year, as exports wane from non-OPEC suppliers such as Mexico and Russia. More of that oil, meanwhile, will flow east to hungry Asian consumers. But neither OPEC nor China provides up-to-date or accurate data on their actions, making it difficult to determine the impact on world-wide demand. "We expect OPEC supply to increase by stealth as demand growth increasingly slips under the radar," says Lehman energy analyst Adam Robinson. That combination, he says, "will add an uncertainty premium to the price of oil."
The market has become so unpredictable lately that many forecasters are recalibrating their forecasts every few weeks -- and rarely are they lowering them. Goldman Sachs Group a month ago expected benchmark crude prices averaging $85 a barrel next year. Then economists there took note of some bullish trends, including signs of robust demand growth in much of the world, and this month raised their forecast to a startling $95 a barrel. For that price to hold, crude prices would have to spend much of the year above $100 a barrel.
Of course, forecasters haven't fared well during the oil-price run-up of the past seven years. More often than not, prognosticators have underestimated the forces that have ended up driving prices still higher. "The graveyard is littered with analysts who have tried and failed so far to call the top in this market," says Adam Sieminski, chief energy economist for Deutsche Bank.
A recent study by Roland Berger Strategy Consultants, of Munich, Germany, found that in making its annual price assumptions, the rich countries' own energy think tank, the IEA, of Paris, missed the actual price by 27% on average since 1999, mostly underestimating how high prices would go. The U.S. Energy Department's Energy Information Agency fared only slightly better, with forecasts that on average came in 22% off the actual price.
The best price predictors, the Roland Berger study found, have been the big oil-producing countries themselves. Saudi Arabia, the world's largest oil producer, always gives itself a wide margin when computing anticipated revenue for its annual budget, which is almost 90% reliant on oil revenue. Wim van Acker, one of the study's authors, says the Saudi government routinely underestimates by 30% what they expect to bring in from oil revenue so as to cushion against the risk of running a budget deficit. Once you add in that cushion, the study found that the Saudi government has been off only 12% on average since 1999.
So what is the world's biggest petro-power saying about 2008? Saudi Arabia's 2008 budget, released last week, is based on a price assumption of around $45 a barrel, according to economists who have crunched the numbers. So with the added margin, Riyadh's prediction for 2008 comes in at around $68 a barrel for Saudi oil -- or more like $75 a barrel for the higher-grade U.S. benchmark crude. That is lower than the analysts' consensus, but not by much.
Analysts agree that the one force that could clearly nudge oil prices lower next year would be a sharp decline in demand in the U.S. and China. So far there is little evidence of that happening. Demand is expected to rise by around 1.5 million barrels a day next year, with more than half of the growth coming from Asia and the Middle East. The top 30 industrialized countries will add only 300,000 barrels a day in extra demand. The world now consumes slightly more than 85 million barrels a day.
If prices do continue to climb, economists may finally get an answer to one the lingering riddles of the decade: At what price will oil consumers begin to recoil? Many thought it would happen at $50 a barrel, then $60, then $70. Until there is a clear answer, and demand begins to taper off, Deutsche Bank's Mr. Sieminski says the best forecasting method may be the one that's ruled for much of the decade. "Take the average of everyone's best guess," he says, "and add 30%."
