Forecasting oil prices is a necessity for oil companies, investors in oil stocks, and for financial institutions who lend to businesses that are directly or indirectly related to the oil industry. The problem, to quote Neils Bohr "It is extremely difficult to make an accurate prediction, especially about the future". It is absolutely correct that nobody knows what oil prices will be. But this common statement is of no value to those involved in the oil business and is not a justification for guessing. There is a level at which oil prices are stable, therefore when short term prices are below or above this level, market forces will attempt to correct the price to its true value.
Many people suggest the way to account for price fluctuations is to present multiple forecasts of permanently high, or low prices as sensitivity cases. This results in confusion for the reader doesn't know what he should believe. Quite often the sensitivity cases are outside the range prices could stabilize at, on a long term basis. This paper claims that longer term forecasts should be based on a single best case only, with financial planners being prepared for short term price weakness which could cause liquidity problems. When the current price of oil is above its long term value, try to take advantage of it, but predict the price will fall within three years.
There are three methods of price forecasting:
Political Analysis: The study of political forces which set prices without limitations of supply/demand forces. Examples are: (I) OPEC controls the oil price and they wish it to be $28/BBL, and escalate one percent above inflation. (2) The U.S.A. needs strategic reserves, so they will tax imports if the price drops too much.
Technical Analysis: The review of historical charts to determine trends. Examples are; (I) 1981 comment: If we extrapolate the last 5 years then the price will go up 15% a year from $34/BBL. 12) 1986 comment: If we extrapolate the last 5 years the price will drop 15% a year from $15/BBL. (3) The Elliott wave theory shows oil will go to $10/BBL. (4) The Kondratieff Wave theory shows oil will go to $5/BBL. (5) The long term chart shows oil trades at $10/BBL.
Fundamental/Economic Analysis: The study of supply/demand factors to determine the price necessary to achieve a mathematical balance. Examples are: (1) The supply/demand balance is at a price of:$20/BBL. The $20/BBL price will remain forever as supply and demand forces will stay constant. (2) The U.S. is running cut of oil and the price has to be $40/BBL for exploration to continue. This price could be paid by consumers as recent conservation has resulted in less crude oil use per consumer.
This paper will perform all three analyses with forecasts under each theory. The price of oil will likely be at various levels forecast by each theory at different points in time, but only the fundamental/ economic analyses can give us an insight into oil's average value over time.
