Future Oil Price Projections Are Living In Parallel Universes

Photo courtesy of Creative Commons

It’s still anybody’s guess as to the future of oil prices.

Crude oil prices fell over the last 12 weeks based on gloomy expectations for the world’s economy. This came after prices rode a wave of $100-per-barrel-plus highs that began during last year’s “Arab Spring.”

The U.S. Energy Information Administration released the 2012 Annual Energy Outlook, which makes short- and long-term projections for energy prices, supplies and demand.

Today, demand seems to be the key force driving the slouch in oil prices. Nearly all analysts agree that prices are falling with the global economy. It all amounts to decreased demand for oil and lower prices. But a host of factors will determine the future of oil prices.

In its prognostications for energy prices, the EIA traditionally provides three sets of numbers: Low case, Reference case, and High case. They are the good, the bad and the ugly of possible energy futures.

The difference between the figures is not arbitrary. Each case takes into account the various factors that affect prices. In the case of crude oil, EIA economists look at, among other things, politics, pipeline capacity, the cost of biofuels, global economic growth (and possible lack thereof) and the share of OPEC-owned oil compared to the oil reserves controlled by non-OPEC countries.

In the best of all possible worlds, the Low Oil Price case, crude prices will actually drop—substantially—in the next five years. The Low case projections look at what would happen if demand for oil holds low, production increases, and biofuel technologies become increasingly competitive. The 2012 Low Case model projects crude oil prices will plummet to $58 a barrel in 2017.

If that sounds optimistic, compare it to five years ago.

The EIA’s 2007 best case scenario—again, the Low case—projected oil at $37.85* a barrel in 2017. That’s less than what it takes to fill an average car up with gasoline today. The 2007 Low case projection for 2012—this year—was $42.23 a barrel, a little more than half of what it’s trading at today. (As of this writing, West Texas Intermediate crude is trading at $80.21 a barrel, according to Bloomberg.)  And that’s after oil went through its longest slump since 2008.

For 2007, the EIA—in its Reference case, which assumes that things will hold steady as they are—projected that crude would cost $57.26 in 2017. The 2012 Reference case for the same year, 2017, puts oil at $123.

Put another way, the conservative 2007 estimate for crude oil prices in 2017 was less than half of today’s conservative estimate for the same year. Make no mistake: Even with the relief in oil prices of the last few weeks, oil is far more expensive than was imagined  possible even five years ago.

And the worst-case scenario? Here it is: Under the 2012 Annual Energy Outlook High case, GDP growth in China and India, along with supply constraints, push oil prices to $186 a barrel in 2017—well more than twice what it’s trading at today. And it just gets worse from there.

The main lesson here is that calculating future of oil prices is as tricky as predicting the future of the world economy—precisely because oil prices have a deep relationship with the global economy. The good news is, when the economy slumps, oil prices tend to do the same, giving at least some relief in tough times.

 *Note: 2007 projections from the Annual Energy Outlook are listed in 2005 dollars, which we have converted to 2010 dollars using the CPI calculator at bls.gov.

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