Forecasting folly: Why forecasts of a rebound in oil prices are prolonging pain

What incentive have US shale operators got to shut production, or the banks that are financing them to pull the plug? Okay, oil prices are hovering about $30 per barrel now, just above operating costs, but if many of the investment banks are to be believed prices are set to rise rise sharply during 2016. Are optimistic forecasts just serving to prolong the period of droopy prices?

The start of the year has seen investment banks tearing up previous forecasts by ~$20 per barrel as the price of oil has sunk during January. But what all (bar one) forecast is a recovery during 2016 and into 2017.

Forecasts for average WTI crude in 2016

Optimistic forecasts are likely to delay any decision by shale operators to cut production. Although operators have cut costs to the bone, none will be willing to cut output just to give a free pass to one of their competitors in terms of higher prices.

The one exception to the optimistic forecasts is JP Morgan who expects WTI crude prices to average $26.50 during the first half of 2016 before rising during Q3 and Q4 which brings the annual average to $31.50 per barrel (pretty much where we are today). They write:

Oil market fundamentals continue to deteriorate pressuring spot and forward prices and elevating volatility. We revise supply and demand estimates in light of weaker economic growth, warmer weather and revise lower 2016 price forecasts. The modal view is that oil markets are set to remain heavily oversupplied in 1H2016, but a muted recovery should develop in 2H2016.

However, risks to the view abound, from political developments, weather and the timing of the now inevitable collapse in oil investment and production in high cost areas, if prices remain as low for as long as we expect. The timing of this last factor remains arguably the biggest risk to the subsequent recovery in price

At the moment shale oil operators have hope. But for how long? It may just require capitulation by the final commodity forecaster to provide the seed for an eventual rebound in oil prices to occur.

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