Drowning in oil? In defence of The Economist’s oil price articles

“Many of the great economic forecasting errors of the past half century came from excessive extrapolation of performance of the recent past and treating a country’s growth rate as a permanent characteristic rather than a transient condition.” – Lant Pritchett and Lawrence Summers

Most forecasters predict a future quite like the recent past. One reason is that things generally continue as they have been, and so major changes just don’t occur very often. Another reason is that most people don’t do “zero-based” forecasting, but start with the current observation or normal range and then add or subtract a bit as they think is appropriate. A bias commonly known as anchoring or recency.

A presentation at this weeks Platts conference in Singapore highlighted how The Economist magazine has apparently fallen fowl of this bias a number of times over the past two decades when it comes to the price of oil. First in 1999, again in 2003 and then in 2016 the magazine has (at least based on the cover) called time on the oil market. Each time the oil market has risen sharply in the year after the articles were published.

However, the title cover or the title of the article never tell the whole story. Delve a little deeper into each article and they were quite prescient. The extract below is from my new book, Crude Forecasts: Predictions, Pundits and Profits in the Commodity Casino.

In what is now one of the magazine’s most infamous articles, The Economist published a report in March 2009 highlighting how the price of oil had fallen to just over $10 per barrel to its lowest level in real terms since 1973. The article postulated whether given the trend in prices since the late 1900s that prices could, and should, fall even further:

Yet here is a thought: $10 might actually be too optimistic. We may be heading for $5… Thanks to new technology and productivity gains, you might expect the price of oil, like that of most other commodities, to fall slowly over the years. Judging by the oil market in the pre-OPEC era, a “normal” market price might now be in the $5–10 range. Factor in the current slow growth of the world economy and the normal price drops to the bottom of that range.

The magazine goes on to list several trends, extrapolations from recent events, that justify prices falling even further. The article cites low production costs in the Middle East and elsewhere as evidence that even if the price of oil rebounded, those low cost producers would quickly raise output in response. It also cites emerging worries over global warming for why oil demand could be lower in the future as countries looked to meet binding emissions targets. Finally, the article also argues that low oil prices would not provide much of a boost to consumption; partly due to new energy technologies and partly due to environmental taxes disguising low oil prices from consumers. No mention was made of China, India or the rise of other emerging economies that were to power the rise in oil consumption over the next 10–15 years.

To give them some credit however, and in a prescient move, The Economist highlighted a risk that was to become important four years later:

In the medium term, however, the Gulf states will find that their revenues recover and even increase with cheaper oil. So once they have made the transition to higher production, a $5 world should not hold any terrors for them. But it may hold more terrors for the rest of the world—for, just as in 1973, it will find that it is increasingly dependent on a few unstable and unreliable Gulf countries, notably Saudi Arabia, Iran and Iraq, for its energy. Cheap oil may not look quite so wonderful, after all.

In a similar vein the 2003 edition ‘The End of the Oil Age’ highlighted the views of former Saudi oil minister Sheikh Yamani who speculated that advances in technology might allow other countries to diversify their energy supplies away from oil, the article concluding that, “One day, these new energy technologies will toss the OPEC cartel in the dustbin of history. It cannot happen soon enough.” Fast forward to 2016, and The Economist notes, “Forecasting the price of oil is a mugs game”. But what they also highlight is the risk that low oil prices means the “world could yet be laid low by an oil monster on the prowl.”

The financial media, then in 1999, as now in 2017 has to serve up content that engages the reader, viewer or listener with a compelling narrative that takes seconds to digest. Watch out for recency bias in the media, but don’t be too harsh on those that are careful to caveat their analysis with emerging risks. As ever, the devil is in the detail. If only you care to look.

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