by frog
I promised to follow up on last week’s Budget Economic Forecast Update, (BEFU), in order to compare it to my own predictions of what Treasury would predict. If you look at the chart from my post before Budget day, you will see that I predicted that Treasury would be lazy and just cut and paste from the futures market, like they always do. Indeed, that is exactly what they did, only they did it far earlier than I did so they look more ridiculous than even my mock up. Here’s what our 2008 budget is based upon:
The pattern looks awfully familiar. Almost identical to what I pointed out last November. Will they ever learn? Perhaps. With oil futures in continuous contango for the first time ever, (ironically the day before the Budget), the world is waking up to the fact that oil really is a finite resource.
Joe Bennett’s hilarious jibe at the economists who live the cornucopian dream is a clear sign that the realities of peak oil are beginning to sink in. Let’s hope that our leaders pull their heads from the sand sooner rather than later.
I won’t slag Treasury off again, as I did it in my post last Wednesday. No Right Turn has done a good job of that since Budget Day.
Published in Campaign | Economy, Work, & Welfare | Environment & Resource Management by frog on Wed, May 28th, 2008
Tags: BEFU, economist, forecast, Joe Bennett, oil, peak, Treasury
on the trolls and those who are unable to keep on topic
This is mind-bogglingly unbelievable. Can they not do simple maths?
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There’s an interesting article on understanding oil futures at the oil drum http://www.theoildrum.com/node/3037
In particular I liked this comparison between financial futures and commodities futures
The article goes on to say that oil futures prices are usually LOWER than today’s purchase price, a situation called backwardation. This situation has now turned around so that future deliveries are more expensive than delivery today.
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Sorry to burst your bubble guys, but Treasury could be right.
I’ve told you before that theres a treshold beyond which consumers won’t be willing to pay for the asking price of oil and it appears we’ve reached that point.
(Bloomberg) — Crude oil fell more than $3 a barrel in New York, the biggest decline since April, on signs that U.S. fuel consumption is dropping because of a slowing economy and record energy prices.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aDZFAy1VgHr0&refer=home
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Not to mention demand in Asia is likely to drop as three large Asian countries have begun reducing their subsidies for oil use, which has contributed to inefficient use in those countries.
http://www.dailyindia.com/show/242793.php/Three-in-Asia-to-cut-oil-subsidies
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Joe Bennett’s piece is amusing, but there is a wee error in it, in that he said the cost of oil extraction is not increasing. Actually the marginal cost of oil extraction has gone up quite a lot. Of course, he’s right about oil company profits skyrocketing too, but that’s because a lot of them have old oil fields that are still providing them with oil at well below the marginal cost of new oil fields.
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Umm, your graph quite clearly shows that oil futures are not in contango, as the futures curve is downwards sloping. I just checked the data, and the curve is still downwards sloping out to late 2010 (after which it slopes upward). Even if the curve was in “continuous contango”, this would be both a) completely normal for any commodity with storage costs b) not evidence that the future spot price is expected to rise (because of the carry costs, a commodities future curve slopes up even when spot prices are expected to remain flat).
I find this whole series of posts quite misleading. If Treasury, or indeed anyone, had a better forecast for oil prices than the future curve, then it would make sense to use that forecast to make massive profits by trading futures contracts. In fact, it would be a license to print money.
You seem to be confusing forecast accuracy (which is very difficult/impossible to achieve for a market-traded commodity) with forecast bias. Using the futures curve to forecast is not particularly accurate, in the sense that there is a wide error band for the forecast. However, it should more or less be unbiased (leaving aside the small carry cost bias), meaning that the future price is just as likely to be too high as too low.
If the Green Party believes that it does have a superior forecast for oil, then why not make it an explicit policy to use oil speculation to supplement fiscal revenues?
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SleepyTreehugger
Don’t introduce facts, you’ll only confuse matters…..
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Meanwhile, in Britain:
The government’s central forecast for the long-term price of oil is just $70 a barrel.
Over the past few months I have been trying to discover how the government derives this optimistic view. In response to a parliamentary question, it reveals that its projection is based on “the assessment made by the International Energy Agency (IEA) in its 2007 World Energy Outlook.? Well last week the Wall Street Journal revealed that the IEA “is preparing a sharp downward revision of its oil-supply forecast?. Its final report won’t be released until November, but it has already concluded that “future crude supplies could be far tighter than previously thought.? Its previous estimates of global production were wrong for one simple and shocking reason: it had based them on anticipated demand, rather than anticipated supply. It resolved the question of supply by assuming that it would automatically rise to meet demand, as if it were subject to no inherent restraints.
Our government must have known this, but it has refused to conduct its own analysis of global oil reserves.
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CPW – The futures market was in continuous contango on the Wednesday before the budget day, not today, as the link shows. This is not a normal thing for the oil market, it was the first time in history. I was pointing out the irony of Treasury forecasting the usual incorrect backwardation forecast on the very day it hit continuous contango for the first time. What is misleading about that?
Furthermore, if you had really been following this series of posts, you would know that there is in fact a forecast which so far has proved amazingly accurate as far as forecasts go, and it was built by Ralph Samuelson over at MED, based on the work of Colin Campbell and ASPO. It was rejected by his superiors as unrealistic but managed to survive as a “minority forecast” in the MED’s Energy Outlook 2006. the model was built in 2005 and if you had invested basedon it, you would be seriously rich right now. I recommend it to you. That original post from last year is here:
http://blog.greens.org.nz/index.php/2007/11/14/cullen-admits-green-is-better-than-red/
I did a follow up in April:
http://blog.greens.org.nz/index.php/2008/04/21/with-oil-forecasts-green-is-still-better-than-red/
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As the US falls into recession depression or downright complete economic collapse (keep your eye on that housing market folks.. down faster and harder than it has ever been since records started being kept and no sign of recovery yet) …
As that happens the support industries for housing will diminish, the available money is already gone, the consumers HAVE to cut back and have been doing so in all manner of ways, not traveling and not buying stuff… the whole shooting match is at risk… which is why the Fed has been pumping money into the system as fast as it can. The deterioration however, will have global consequences and the diminished economic activity WILL drop the price of oil, which is set at the margin, because the supply is more than adequate to a Global Economy that has shrunk 10% or more…
The flip side of that is that the supplies are not increasing… the fields found are smaller and less accessible than previous finds, the “peak” is quite real. The assumptions about the peak however, that it will be solely a result of global economic activity that is constantly increasing rather than also in part a dictator of activity that varies for a number of reasons, are not supportable.
Weighing against that is the increasing demand from the rest of the world for crude. This may pick up the slack the US puts down, but I suspect that the effects of the US falling back towards the mean will include a diminished demand elsewhere as well.
So the price can go down. From here. Yes. In real terms but….
Not nearly so much in US $ terms… remember that the Fed is pumping money as fast as the Saudi’s pump oil.
None of this changes the view that as the world attempts to pull back from the depression economics that appear to be enveloping it, it WILL find that there is less oil. It takes millions of years to make a barrel of the stuff and there won’t be “more” anytime soon.
If we do see $70 oil (assuming constant dollars, nominal dollars will be more…) it will not be because peak oil isn’t driving price, it will be because it isn’t the only thing driving it, and it won’t be anywhere near as comfortable an economic situation as the folks who are touting it seem to imagine. Personally I expect the fall to depend on the degree of economic destruction that occurs outside the oil patch… I would predict $85-$100 for a bottom and once it starts rising from there the ball game is over.
I’ve been saying that the thing that is most likely to save our collective butts is a global depression… both in terms of warming and peak oil… I have seen no reason lately to change that opinion.
respectfully
BJ
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Sleepy – I have repeatedly said in my posts that I didn’t think that the current spike was sustainable as it was well above the already exponential price trend line in my spreadsheets. This does not mean that the price pressures are not real and will not continue. I’m sure we’ll have a correction but it won’t be taking us back to the good old days.
Can you really argue that having been seriously wrong in all 8 of their last forecasts that Treasury is improving its game this time? Surely not SleepyTreeHugger!
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I see some common ground here.
Do we all agree that it would be better if New Zealand wasn’t reliant on world energy supplies? If so, and we can develop our own at lower cost, we benefit.
Can we do so?
If we can, we should.
That’s a pitch everyone would get behind, surely….
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BJ – I would have put the correction price in the same range as you just a few weeks ago, somewhere in the $85-100 range. I’m not so sure we’ll dip that low without a complete economic meltdown, which I don’t see coming for a while. We have a nice comfortable plateau of production at the moment which is cushioning the effect because it’s giving us time to adjust to higher prices. This plateau has been going since the middle of 2004. Long may it last!!
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I’ve been reading Paul Krugman’s “The Great Unravelling”. Much of the first half of the book was written before 9/11, yet it broadly forecasts what we are seeing now. The cause? The Bush tax cuts of 2001. They charted the course from huge surpluses to huge deficits BEFORE 9/11. Over US$2.3 TRILLION in shortfalls at a time when the US should be saving for pensions and medicare for baby boomers. Krugman said this could only lead to higher interest rates and inflation and the decline of the US dollar with that entails. Enter Iraq and another mountain of waste plus destabilised oil markets and supplies. This is all without Peak Oil! Plus every link in the oil supply chain, from producers to refiners, has an interest in high prices. Sleepy’s Bloomberg link above, reading between the lines, points to oil being held hostage in Russia by oil moguls seeking tax cuts. This pattern is being repeated around the world everywhere. People who control oil are using it for maximum political and financial leverage.
OPEC says there is no shortage of oil. The prices are due to rampant speculation. It’s desperately hard to separate the real from the unreal in the narratives being laid out by all these self-interested parties. There is no one true source of information.
For example, if “oil inventories” take a downward trend in the US, does that mean oil is harder to get? Or does it mean someone is lagging on orders to chose supply by 1% or 2%? If oil is adequate in inventories, is it being refined fast enough to meed demand? Or did someone take a refinery offline for “maintenance”?
Oil has SO MANY potential choke points, each in the hands of some monopoly or cartel or similar, it would not be hard to create the impression of shortage for mutual profit using a nod and a wink…..never mind overt conspiracy.
Meanwhile, demand fell in the US by 1.3% over last year….while imports last week were down 2.4% over last year…..Oil companies trying to prudently forward track anticipated fall in demand? Or trying to maintain a tight supply situation?
Flip a coin.
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The IEA data has been regarded by many as wildly optimistic for many years, forecasting the oil peak at not earlier than 2032 if memory serves. Then last year they come out with a blockbuster revision…
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I find it hard to see how oil can get back down to $70 simply because of the Fed. I don’t know if the readers of this blog realize just how much money has been created in the last year. The Fed is going to print money that is their only way of keeping the US going and if the last year is anything to go on they will print as much money as they want. All that money means one thing inflation and the supply and demand of a commodity priced in a ccy which is being inflated is moot. If demand for oil falls it wont lower the price thanks to all the printing thats going on.
The demand and supply of oil is only going to control how much oil increase’s buy
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turnip28,
Yep I have to admit that Treasury is going out on a limb claiming that Brent will drop to $70 a barrel, because with the dollar being so volatile and the FED “printing presses” running hot, people are likely to denominate their assets in something tangible.
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ye gods, it looks like some kind of hideous insect!
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I think it looks like a promotional add for Viagra.
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i guess even with viagra, what goes up must come
down
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Frog, your previous graph wasn’t in continous contango either, but quibbling aside, I can’t find any verification for your claim that this is the first time ever. I just pulled up the daily data back to 1991, and the one year and two year future contracts have been in contango 30% of the time over this period. And even if it was the first time ever, it still doesn’t imply what you suggest it does.
If you think about how a future curve works for something like oil works, its becomes pretty obvious that a flattish curve should not surprise us. A steeply rising curve can’t exist for long before people start buying spot and selling futures, flattening it out again. So consensus predictions for higher future prices quickly manifest as higher spot prices. You’d be on safer ground if you just said that higher spot prices suggest permanently higher future prices (which they do).
I’m familiar with your previous post on the MED forecast. It is always the case that ex-post we can find forecasts that were accurate with hindsight;
by itself, this is not normally good evidence that they were good forecasts ex-ante.
This paper is a good primer on oil prices movements and forecasting: http://dss.ucsd.edu/~jhamilto/understand_oil.pdf
My reading of the empirical evidence suggests two fairly uncontroversial conclusions:
1) Oil prices are near impossible to predict
2) Given 1), assuming prices will follow the future curve is as sound as any other method
Since you have yet in this series presented any evidence to contradict either 1) or 2), it’s hard to see your criticizing of Treasury’s forecasts as anything other than pandering to the masses – hence my description of it as misleading.
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CPW Says:
May 28th, 2008 at 4:05 pm
> If you think about how a future curve works for something like oil works, its becomes pretty obvious that a flattish curve should not surprise us. A steeply rising curve can’t exist for long before people start buying spot and selling futures, flattening it out again.
But you can’t buy oil supply in the present and convert it into oil supply in the future unless you have somewhere to store it.
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Kanikatea: You store it in the ground. A futures contract for oil 9 years out certainly will NOT be pumped today. The way I understand it, you’ve paid for oil that will be pumped in 2016 (for example). They took your money today.
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OutinFront They took your money today.
No they didn’t. The futures market does not work that way.
A margin will have been paid, depending on the difference between the value of the trade and the spot price. The margin call is adjusted every month.
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OutinFront Says:
May 29th, 2008 at 4:32 am
> Kanikatea: You store it in the ground. A futures contract for oil 9 years out certainly will NOT be pumped today.
Yeah, but if you want to buy oil that’s sold as present supply and convert it into future supply, can you keep it in the ground? You can’t if you’re a speculator, only if you’re an oil mining company. And the oil companies have different interests from speculators. Have you heard the French proverb about the frog in boiling water? If you put a frog in hot water, it notices it’s too hot and jumps out. If you put a frog in cold water and heat it up slowly, it doesn’t notice when it’s too hot, so it never jumps out. The oil industry likewise has an interest in the oil price going up slowly enough that it won’t shock people into reducing oil dependence, or cause a depression that will lead to lower demand for oil.
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Fastbike: Thanks. Margin – not full price. I’m learning.
Kahikatea: I wouldn’t think so. If you’re buying oil for supply now, you’ll have to store it somewhere when its delivered. That’s why you wouldn’t buy it until you need it, and you’d do that via a futures contract or some other ordering arrangement. I’m sure not all oil goes through the markets. Sudan’s oil to China won’t be appearing on any exchange, I would assume. As for returns, we would have to do the math on returns. If you’re getting 100% more for your oil than a year ago, you don’t care if demand falls by up to 50%…..’cause you’re still making the same amount of money….or more. People who are making billions don’t much care what happens to the other guy(s).
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