Robin Mills: Glorious ongoing uncertainty of energy markets

Energy economists are used to being asked what oil prices will do in the year ahead. Last month, 11 economists, including Robin Mills, put their professional reputations on the line by predicting the oil price on 31st December this year.

The oil services company Baker Hughes said that US oil rigs in use were up another five in the latest week at 658. Jacob Ford / Odessa American via AP

President Truman, frustrated with economists who said "on the one hand this … on the other hand that", said, "Give me a one-handed economist!" Energy economists are used to being asked what oil prices will do in the year ahead. Last month, 11 economists, me included, put our professional reputations on the line by predicting the oil price on December 31 this year.

The bets were collated on Twitter by Leslie Hayward (@leslietron) of Securing America’s Future Energy, a non-profit campaign group. They range from a low of US$32.70 per barrel to a high of $73.20 (compared to the closing price of Brent crude at $57.10 per barrel on Friday). My own forecast, derived after rigorous analysis of the market – and the addition of a crucial extra cent – was $55.01.

But most of the predictions were in quite a narrow range, from $55 to $70. This shows a general expectation that prices will rise during this year, but not too much. Given the market volatility over the past two years, to come even within $15 of the actual price would be some achievement.

This band has been adopted by many analysts as the level at which solid, but not explosive, expansion of US shale oil production will cap prices. The deal between Opec and non-Opec countries to reduce output will help to rebalance the market, even with imperfect compliance. The enormous overhang of oil stocks will gradually be drawn down, perhaps from the third quarter of this year, but will prevent any price surge.

But groupthink is dangerous. The point at which most economists agree is usually the time for a surprise. What would drive a shift from this cosy consensus?

Without second-guessing my fellow competitors’ reasons for their forecasts, a very low price is not likely to be the outcome of excess supply. US shale oil drilling is rebounding strongly with the rise of prices to the $50 level, with the number of active rigs reaching its highest point in a year on Friday, more than double where it was in May.

But if oil prices again drop to $40 or below, shale oil development will drop off again. Before the Opec cuts, most countries were close to their maximum output anyway, with increases in Nigerian and Libyan output subject to security vagaries. The deal could of course collapse, but if it does, that seems most likely to be at the end of the initial six-month period, not the year end.

So what would the most likely cause of low oil prices be? The obvious culprit here is the world economy – perhaps the bursting of a bubble in China, or a Donald Trump-inspired trade war.

The possible causes of high oil prices are more varied. Two possible scenarios are as follows. In the first, Opec members stick to their planned production cuts – indeed, Saudi Arabia and Kuwait have already pledged to go beyond their commitments.

Meanwhile, the North American shale business finds it harder to ramp up output than expected. Costs for inputs such as drilling rigs and labour rise along with demand, and skills shortages bite. Financiers, stung by losses over the past two years, are reluctant to extend more capital. The cumulative effects of three years of capital spending cuts see production dropping in mature and high-cost areas around the world.

The second scenario is based on geopolitical risk – an upset in a major oil producer. Perhaps Venezuela, sliding ever closer to economic and political breakdown, is the best candidate.

Such outcomes lie outside the domain of humble energy economists, and into the realm of macroeconomists and political scientists. By the end of December, the game may be decided by supply, demand, Opec, shale, geopolitics or another entirely unexpected factor. But that is part of the glorious uncertainty of the market for oil, the king of commodities.

Robin Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis.

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