Forget Oil Price Forecasts, It’s Just Another Cycle

Profit season in the oil industry is in full swing, and the mood is upbeat: strict financial discipline is paying off, cash flows are improving (or emerging after a long absence), and the industry is growing again. And there are those who claim that we have seen the last big oil price collapse.

Some beg to differ however. A notable voice among the skeptics is Reuters market analyst John Kemp. In a recent column Kemp lays out in detail the reasons why the “It will never happen again” refrain is wishful thinking at best and delusion at worst. The oil industry, he says, has a cyclical nature. Learning from past mistakes, while a good thing generally, cannot help avoid the next bust because boom and bust is the very nature of oil.

With the scars from the last bust still fresh, the oil industry is being cautious with new investments, just as it has been after every single bust since the dawn of oil, Kemp notes. Oil companies are suspicious of the price rise, uncertain it will last. And they are quite right to be suspicious, because no boom ever lasts as history has proven time and again. The problem is that nobody can predict the end of the next cycle and the beginning of a new one, hence the caution.

So, if nobody can predict the next price collapse, what is the point of having analysts fall over themselves to forecast the unforecastable, namely, future oil prices? Well, here’s a pertinent quote from John Kenneth Galbraith: “Economists don’t forecast because they know, they forecast because they’re asked.”

Economic forecasts are notoriously inaccurate, and this is particularly and very emphatically true of oil price forecasts. Here’s another quote, from Rex Tillerson: “We’ve never been good at predicting these (price) cycles, neither when they occur nor their duration. We don’t spend a lot of time even trying.” That’s certainly a smart approach and one that must pay off by saving time, effort, and money. Related: Are Investors Turning Away From Big Oil?

The reasons why predicting the next oil industry cycle is mission impossible come down to the makeup of the oil market and the huge diversity of external factors that have a bearing on prices, and therefore on the cycles. The oil market, Kemp says, is actually a collection of numerous submarkets, and these are well-nigh never in balance. When they are in balance, it’s only for a very short time, so the phrase “balancing the market” is basically nonsense.

Outside the market there are thousands of events that can affect oil prices and there is no way on earth anyone can account for each and every one of these thousands of events, ranging from local politics in oil producers and consumers to force majeure events. As Bill Gilmer, director of the Institute for Regional Forecasting at the University of Houston puts it, the world does not stand still, so the chance of any one analyst or Big Oil CEO getting the price right is pretty much the same as the chance for a tail or a head in a coin flip.

So, what is an industry to do in this environment of chronic uncertainty? Ride the cycle, Kemp says. So, producers vow to continue with the strictly disciplined approach to investments. The result will be higher prices stimulating alternative producers, a supply build, and a subsequent fall in prices. Just like every other cycle. The only thing producers could reasonably do, whether Big Oil or OPEC, is plan for the long term and learn to live with the short-term uncertainty.

By Irina Slav for Oilprice.com

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