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Energy Di v is1 on
£nergy and Economic Analysis Section
f~e~.tt. lO
ORNL/Tt+-9521
FUlURE WORD OIL PRICES: MODELING ME1HOOOLOOIES
AND SUMMARY OF RECENT FORECASTS
T. Randall Curlee
Date Publ fshed:' March 1985
Prepared by the
O.AJ< RICGE NATION~\. L,4BORATORY
Oak Ridge, Tennessee 37831
operated by
MARTIN MARIETTA ENEFGY SYSTEMS, INC.
for the
U.S. DEPARTMENT OF ENERGY
under Contract No. DE-ACOS-840R21400
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TABLE OF CONTENTS
4
. . . . . . . . LIST OF FIGURES •
LIST OF T,IBLES . . . . .. . . . . . . .
. . . iv
. . . . . . . v
MSTRACT • . . . . . . . . . . . . . . . vi
Chapter 1: INTRODUCTION . . . . . . . . . . . 1
Chapter 2: METHODOLOGIES TO EXPLAIN WORLD OIL PRICE BEHAVIOR • 5
I. Introduction • • • • • • • • • • • • • • • • • 5
II. A Brief Overview of Historical Changes in the
World 011 Market • • • • • • • • • • • • • • • 5
A. The 196Q-73 Time Period • • • • • • • • • 6
B. The 1973-81 Time Period • • • • • • • • • 7
C. The 1981 to Present Time Period • • • • • 11
III. Methodologies Developed to Explain and Forecast
Oil Prices • • • • • • • • • • • • • • • • • • 15
A. Economic Models • • • • • • • • • • • • • 18
1. Optimization Models • • • • • • • • • 18
2. Simulation Models •••••••••• 23
B. Political Models • • • • • • • • • • • • • 25
C. Combination Models • • • • • • • • • • • • 27
IV. Conclusions ••••••••••••••••• 28
Chapter 3: WORLD OIL PRICE FORECASTS • • • • • • • • • • • • • 31
I. Introduction • • • • • • • • • • • • • • • • • 31
II. Forecasts Based on Expert Judgment • • • • • • 32
III. Forecasts Based on Formal Models ••••••• 36
A. The Forecasts • • • • • • • • • • • • • • 37
B. Sensitivities of Forecasts to Changes in
Key Parameters • • • • • • • • • • • • • • SO
1. Long-Run Oil Price Elasticity of Demand 53
2. GNP Growth • • • • ·• • • • • • • • • • 54
3. Oil Supply Price Elasticity ••••• 55
4. Interest Rates • • • • • • • • • . • • 57
5. The Backstop Price ••••.••••• 57
IV. Surveys of 011 Price Forecasts • . • • • • . . 58
Chapter 4: CONCLUSIONS • • • • • • • • • • • • • • • • • • • • 61
REFERENCES
I. Introduction • • • • • • • • • • • • • • • • • 61
II. A Summary of Conclusions from Previous Chapters 62
III. A Subjective Assessment of Future Market Trends 65
IV. Future Oil Prices .••••.•••.•••• 70
V. Final Conclusions •.•.••••.••••• 74
. . . . . . . . 75
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LIST OF FIGURES ..
Figure
2.1 Methodolog~es to Forecast World Oil Prices • • • • • • • • 17
3.1
4.1
Sensitivities of EMF-6 Price Forecasts •• 52
EMF-6 Price Projections Given a Permanent 10 Million Barrel
Per Day Capacity Reduction • • • • • • • • • • • • • • • • 73
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LIST OF TPSLES
4
Table
2.1 Official Prices of Saudi Arabian Light and Nigerian Crude
for Se 1 ected Dates • • • • • • • • • • • • • • • • • • • • 16
3.1 A Summary of Oil Price Forecasts Arranged by Year Published 38
3.2 A Summary of Oil Price Forecasts Arranged by Year Published
<In constant 1981 dollars) •.•••••••••••••• 40
3.3 A Summary of Oil Price Forecasts Arranged by Modeling Type 42
3.4 A Summary of Oil Price Forecasts Arranged by Organization
Making Forecast • • • • • • • • • • • • • • • • • • • • • 44
3.5 A Summary of Oil Price Forecasts Arranged by Projected 1990
Price Level . • • . . . . • . • •.•. , • • • • • • • • 46
3.6 Scenario Assumptions Used in.the EMf-6 Study.
3.7 OECD Oil Supply Elasticities: EMF-6 Models . . . .
3.8 Results of the 1983 and 1984 IEW Surveys
.
4.1 011 Price ProJections: 1987 to 2022 •.•
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56
60
71
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4 FUTURE WORLD OIL PRICES: MODELING METHOOOLCGIES
AND SUMMARY OF RECENT FORECASTS
T. Randall Curlee
Energy and Economic Analysis Section
Energy Division
Oak Ridge National Laboratory
ABSTRACT
This paper has three main objectives. First, the various
methodologies that have been developed to explain historical oil
price changes and forecast future price trends are reviewed and
summarized. Second, the paper summarizes recent world oil price
forecasts, and, when possible, discusses the methodologies used in
formulating those forecasts. Third, utilizing conclusions from the
reviews of the modeling methodologies and the recent price
forecasts, in combination with an assessment of recent and
projected oil market trends, oil price projections are given for
the time period 1987 to 2022.
The paper argues that modeling methodologies have undergone
significant evolution during the past decade as modelers
increasingly recog~ize the complex and constantly changing
structure of the world oil market. Unfortunately, at this point in
time a· consensus about the appropriate methodology to use in
formulating oil price forecasts is yet to be reached. There is,
however, a general movement toward the opinion that both economic
and political factors should be considered when making price
projections.
Likewise, there is no consensus about future oil price trends.
Forecasts differ widely. However, in general, forecasts have been
adjusted downwardly in recent years. Further, an overall
assessment of the forecasts and recent oil market trends suggests
that oil prices will remain constant in real terms for the
remainder of the 1980s. Real oil prices are expected to increase
by between 2 and 3 percent during the 1990s and beyond.
Forecasters are quick to point out, however, that all forecasts are
subject to significant uncertainty.
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.. 1. INTRODUCTION
Between the years 1973 and 1982 the nominal price of oil on the
world market Increased by more than 1600 percent--from $2.10 to
$34.00 per barre1.1 Further, the price Increases were sudden and
sharp, Increasing from $2.10 to $9.60 per barrel between January
1973 and January 1974 and from $13.34 to $26.00 per barrel between
January 1979 to January 1980. These price escalations--both In
terms of their stze and their occurrence over a relatively short
time period have caused. and continue to cause, significant
Impacts on economic activity, social structures. government
programs, and Jnternatfonal relations. These price escalations and
their resulting Impacts have also spawned a host of studies that
espouse particular methodologies for explaining historical price
changes, as wei I as for forecasting future price trends. Yet more
than ten years after the start of the so called "Energy Crisis"
there exists I lttle consensus about how the world oil market
functions and, more speclflcal ly, how world oil prices are
de term I ned. This Is not an·unexpected outcome, given the accuracy
of prevIous forecasts. Further, the poor accuracy of previous
forecasts Is not altogether surprising, given that the model lng
assumptions used In those forecasts did not reflect the unexpected
and what most would argue were unpredictable --market
disruptions ot 1 973-74 and 1979-80. Work continues to study the
structure of the world oil market and the mechanism by which oil
1 Price quotes are for Saudi Arabia I lght crude, the official
marker crude for the Organization of Petroleum Exporting Countries
<OPEC>.
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prices are determined. Work also continues to forecast oil prices
using models with wJdely divergent underlying assumptions.
The purpose~ of this· paper are threefold. First, the paper
rev Jews and
to explain
summartzes the various methodologies that have evolved
historical oil price changes and to forecast future
price trends. Second, the paper summarizes the numerous world oil
price forecasts that have appeared in recent years and Identifies,
when possible, the methodologies and underlying assumptions used in
formulating those forecasts. Third, utilizing the conclusions
drawn from the reviews of the model Tng methodologies and the recent
price forecasts, In combination with an
projected oil market trends, oil price
the time period 1987 to 2022.
assessment of recent and
projections are given for
Since the oil price shock of 1973, numerous theories and models
have been developed that supposedly represent the functioning of
the world oil market. In Chapter 2 these various 'views of the oil
market are reviewed and categorized into three major groups --
economic models, political models, and models that combine aspects
of the two approaches. Under each of these three main headings
there Is additional dJsaggregatJon to reflect different objective
functions, structural assumptions about the world of I market, and
so forth. Gtven the large number of oil models, It Is not feasible
nor necessarily productive --to attempt to review each
Individual model. Rather, this review points out commonal Itles
among the models and methodologies with the purposes of (1)
suggesting the relevant players that determine the price of world
of I, <2> suggesting the objective functions of those players, and
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(3) s~ggesttng the degree to which each of the players Is able to
manipulate the market to maximize or satisfy their objectives.
Another lmporta~t aspect·of this review Is the Identification of
the major parameters that have Impacted, and can be expected to
Impact, world oil prices under the different methodologies. As
wfl I become apparent. there are numerous ways that the world of I
market can be modeled. Further, each of those approaches have
certain credlbl lltles --as wei I as handicaps--In explaining
historical oil price changes. However, different methodologies m~_
suggest very different reasons why oil prices m~ have changed In
the past and why prices may change In the future. Depending upon
how one characterizes the world oil market, the lmpl lcatlons for
how future oil prices may change are quite different.
In Chapter 3 the numerous oJI price forecasts that have been
publ Jshed Jn recent years are reviewed and summarized. In
addition to reporting how different forecasters view future oil
price trends, the chapter Identifies, where possible, the model Jng
methodologies and assumptions about key parameters used to obtain
the forecasts. Of particular Importance are the sensitivities of
the different forecasts to changes In major Input parameters. An
additional point of Interest Is how forecasts of mid-term and long-
term oil prices have changed since the official oil price reduction
of 1983.
In the final chapter the conclusions from Chapters 2 and 3 are
used In combination with an assessment of current and projected oil
market conditions to select high, medium, and low oil price
projections for the tlme perlcd 1987 to 2022. In addition to
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selecting business-as-usual price paths --I.e., paths for which
the baste structure of the world oil market remains unchanged--
two price path~ represen-ting the breakup of the oil cartel and the
occurrence of a significant oil supply disruption are discussed.
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• 2. METHOOOLOOIES TO EXPLAIN WORLD OIL
PR ICE 8 EHAV I OR
I. lntrocluctto~
Thts chapter reviews and summarizes the various methodologies
that have been developed to explain historical world oil price
changes and forecast future oil price trends. The methodologies
are categorized Into one of three broad groups--(1) economic, (2)
pol tttcal, and <3> economic-pol tttcal combinations. In addition to
explaining how the different methodologies view the relevant
players In the world otl market and the objective functions of
those players (If any>, the review Identifies the major parameters
relevant to each major methodology that are argued to have
Impacted, and are expected to Impact, world oil prices.
However, before those methodologies are addressed In detail, a
brief historical review of major developments In the world oil
market Is necessary to understand why particular methodologies have
evolved. That review Is presented In the next section.
II. A Brlef Overview of Hlstorlcal Changes ln the World Oll Market
For our purposes the post-OPEC era of the world oll market can
be divided Into three tlme periods--1960-73, 1973-81, and 1981 to
the present. An examination of each of these periods spel Is
significant changes not only ln the levels of world of I prlces, but
also for the relevant players and market structural condltlons
under which those players acted Individually or as a group to
determine or at least Impact world oil prices.
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A. Tne 196Q-73 TT me Pert od
The Organization of Petroleum Exporting Countries <OPEC> was
formed In 1960 (lnd consisted of five members--Iran, Iraq, Kuwatt,
Venezuela, and Saudi Arabta. At the time of the formation of OPEC,
the oil producing nations wfthin OPEC, and the other oil producers
that would later jofn the organtzatton, had I ittle power over
production decrstons wlthfn thefr own nations, and of course even
less Influence on world oil prtces. During the 1950s and most of
the 1960s the production and trade of ofl from the <to become> OPEC
countries was control led to a great extent by the major
internatfo~al oil companies. World otl prices were generally below
the $2.00 per barrel level and international oil companies held a
very high equity Interest In the crude production of the major OPEC
producers. The taxes received by the producing countries from the
production of a barrel of oil were very low.
The objectives of OPEC tn its early years were rather
unambitious as compared to later years. The producing countries
attempted to (1) gain control over the level of production in their
own countries, (2) change the tax system by which the producing
countries received revenues from the major of I companies so as to
Increase the total revenues to the producing countries, and (3)
gain greater equity interest In the production operations tn their
own countries. However, to a great extent the productng countries
did not begin to effectively use their tnternational power until
around 1970. For example, In January 1970 the new radical Libyan
government forced
International oil
--or threatened with national tzatlon --the
companies operating within Libya to renegotiate
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their oil prices. This event was probably most Important In that
It provided a raJ lying point for other oft producers and brought
the real Jzatlon_that the ·producing countries had considerable power
to Impact the oil market. Later In 1970 both Algeria and Iraq won
concessions from the oil companies over prices and Investment
plans. These events seemed to set off a series of successful price
and benefit demands made by the producing countries.
The major point to note from the review of this period Is that
the'major oft producing countries gained signlfJcant power In
determining both the price and productlon of oil In their own
countries and therefore became a new and powerful player In the
determination of world oil prices. In other words. there was a
change In (1} the relevant players In the determJnatlon of oil
prices. <2> the feasible objectives of those players. and (3) the
abl I ltles of the different players to manipulate the market. or at
least their segments of the market. to real lze those objectives.
Although the feasible objectives of OPEC remained I Jmlted --
compared to future standards --the organization had become a power
to be dealt with In the world oil market.
B. The 1973-81 Time Period
Between the years 1973 to 1981 the world oil market changed
tremendous I y. Previous to the major events of 1973-74 the
producing countries had attempted to obtain a larger share of the
economic rents that had gone to either the International oil
companies or to the treasuries of the consuming countries ln the
form of taxes. (Prlces of petroleum products were much higher
during the 1960s and early 1970s than could be accounted for by
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crude 4 prlces. For example, prfces for gasol lne In Europe were In
the $30.00 per barrel price range reflecting high domestic tax
levels.) Afte~ 1973 the·produclng countries not only continued to
transfer the wealth that was previously obtained by the oil
companies and the governments
obtained additional wealth by
crude to consuming countries.
of consuming countries,
directly Increasing the
but also
price of
The first major price jolt of the 1970s came In October 1973
when six major Persian Gulf producers --Abu Dhabi, Iran, Iraq,
Kuwait, Qatar, and Saudi Arabia--agreed to raise the posted price
of Saudi marker crude from $3.01 to $5.12 per barrel. Then In
January 1974 the Organization of Arab Petroleum Exporting Countries
COAPEC) further raised the posted price of Saudi marker crude to
$1 1 .65 per barrel, ref I ectl ng more than a 380 percent I ncr ease t n
posted prices over the pre-October level. These huge price
Increases, of course, occurred during the time of the Arab oil
embargo against oil sales to the United States and the Netherlands
because of their support of Israel In the 1973 Arab-Israeli War.
However, close Investigation of that embargo shows that although
approximately 98 percent of the ol I from OAPEC producers was halted
to the U.S., Increased Imports from other sources helped to
mitigate the Impacts of the embargo. One factor that helped reduce
the Impacts of the embargo on physical flows of oil was the fairly
good control that the major oil companies retained over the
distribution of world o! I. While OAPEC oil co~ld not be sent to
embargoed countries (because of threats from the ol I producing
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counttles>, other oil could easl ly be rerouted to the U.S. and the
Nether I ands.
Sfmultaneou~ly, several producers reduced production In
response to the embargo. In October 1973 Saudf Arabia, Kuwaft,
Dubaf, and Algeria cut production by over 5 percent. These same
countries cut production by a minimum of 25 percent In November
1973, and both Abu Dhabi and Qatar came very close to these targets
during the same tfme period. However, production cutbacks began to
diminish in December. By January 1974 production cutbacks in these
countries were only about 10 percent. Further, it Is Interesting
to note that not alI OPEC countries participated in the production
cutbacks and some even Increased production. For example, Libya, a
major supporter of the embargo, met the OAPEC mandated 25 percent
reduction only tn November. Production actually Increased by about
4 percent In Iran, Indonesia, and Nigeria. Therefore, the rather
moderate production cutback was maintained for only about three
months and was not shared equally by alI OPEC members.
The period 1975 to 1978 was relatively tranqul I as the world
attempted to adjust to the huge price Increases of 1973 and 1974.
In nominal terms world oil prices continued to Increase at between
5 and 10 percent per year, while In real terms the price of ol I
actually decl lned.
The second major jolt to world ol I prices followed the start of
the Iranian Revolution In late 1978. Oil exports from Iran were
reduced In September 1978 and by December 1978 virtually alI
Iranian oil exports had halted. However, In terms of total free-
world of I product ron, the Iran! an Revol utlon did not result In
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large~ productJon losses due to production Increases In non-
disrupted countrJes. While total free-world production was reduced
by about 4.5 p~rcent between December 1978 and January 1979. free-
world production was very nearly back to Its pre-disruption level
by March 1979.
Therefore, as was the case In 1973-74, the disruption was not
long term or severe. However, the oil price changes that resulted
during this time period were severe. Between July 1978 and January
1981 the official price of Saudi I ight crude increased from $12.70
to $32.00 per barrel. Various arguments have been put forth to
explain these huge escalations. Certainly, production reductions
by Saudi Arabia during this time period contributed to the
increases. Further. same have argued that between the,dJsruption
of 1973-74 and the Iranian Revolution of 1978 there was a major
structural change In the role of the major oil companies in the
production and distr!but!on of o!l from the OPEC countr!es. It !s
argued that less control over the d!str!but!on of available ol I by
the major o!l companies led to !ncreased competit!on for available
oil on the spot market. drastlcal ly Increasing spot pr!ces, and
eventually leading to official pr!ce escalations.
Whatever the underly!ng reasons for the pr!ce !ncreases, same
obvious market structural changes occurred during the 1973 to 1981
' time period. Ff rst. OPEC, and the OAPEC countr!es !n part!cular.
ga!ned tremendous market power as compared to the prev!ous era. No
longer was OPEC an organization that attempted to siphon off o!J
wealth that had previously gone to consum!ng countr!es and major
or 1 compan res. OPEC, or at least a subset thereof, was now the
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leader of the world ofl market wtth power to make productfon
decfstons, Jf not Jn fact to set oil prices. Second, the OPEC
countries wtth thefr newfound otl wealth had begun ambitious
development programs that not only changed the nature of their
economic and social structures, but also demanded the continuation
of large Infusions of oil revenues If those programs were to
continue. Third, the major oil companies had lost much of their
abl I tty to control the dtstributton of crude and in so dotng had
lost some abll tty to "smooth out" short-term and relatively minor
supply disruptions. Ftnal ly, oil consumers and non-OPEC producers
had begun the long adjustment process to the huge price Increases
of the 1970s and early 1980s.
However, the oil producing nations clearly maintained control
of the world oil market, despite the facts that oil consumption was
betng reduced through capital replacement, factor substitution,
etc., and non-OPEC production was on the rise. The rel-ative power
of the players In the determination of world oil prices had
changed, and with that change came drastic escalations In world oil
prIces.
C. The 1981 to Present Time Period
Although throughout the 1970s the price of crude on the world
market appeared to be downwardly rigid --at least In nominal terms
--a series of events began around the first part of 1981 that
suggested a reduction In the strength of OPEC In relation to non-
OPEC o II producers and major consumIng countries. In September
1980 t lghtl ng began between two OPEC members -"':' I ran and Iraq --
resulting In drastic reductions In exports from those countries.
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lrant~n exports decreased by about 1 mil lion barrels per day--
Iraq's by about 3 mil !Jon barrels per day. While the size of the
disruption In . percentage terms was about the same as that
accompanying the Iranian Revolution --about 4 to 5 percent of
free-world production --the Impact on the price of oil was
significantly less. There are several reasons prices did not
escalate as during previous disruptions. Certainly, the record
level of oil stocks at the outbreak of the war contributed to the
calm. Further, the consumption of oil In the world market was
decreasing as a result of a worldwide economic slowdown and as a
result of the addition of more efficient fuel use capactty. For
example, U.S. consumption of refined products decreased from a peak
of 18.8 mil lion barrels per day In 1978 to 15.3 mJI lion barrels per
day In. 1982. World consumption decreased from a peak of 65.1
mil I Jon barrels per day In 1979 to 58.9 mil lion barrels per day In
1982. In addition, non-OPEC producers had responded to the huge
price Increases of the 1970s by sharply Increasing their own
production levels. While total OPEC production decreased from a
high of about 31 million barrels per day In 1979 to 17.3 mill ton
barrels per day In May 1984. production In non-OPEC, free-world
countries Increased from 17.6 to 21.5 mil I ton barrels per day
during the same time period. In addition, the Soviet Union
Increased oil exports to the free world from 1.28 to 1.54 mil I ton
barrels per day between 1980 and 1982.
The pressures exerted on OPEC's pr I cl ng structure by non-OPEC
production Increases and decreases In worldwide oil consumption
resulted In an Increasing discrepancy between official OPEC prices
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and crude prf"ces on the spot market. In response to these
pressures OPEC met In March 1983 and announced a $5 reduction In
their benchma~k price from $34 to $29 per barrel. At the same
meeting OPEC agreed to set an overal I output cell lng for the
organization at 17.5 mil lion barrels per day, with the majority of
the production constraints being borne by the major oil producers
of the Persian Gulf.
While the actions taken by OPEC at the March 1983 meeting
helped to stabll lze oll prices and prevent further erosion of
OPEC's powerbase, other problems threatened OPEC's future control
of the world oil market. For example, to maintain the ambitious
development programs begun by many of the oil producers In the
1970s, large Inflows of oil revenues were needed. However, because
of Increased competition from non-OPEC producers, oil demand
reductions, and the official OPEC price reduction, same development
programs were threatened. These pressures resulted In Increased
compet!t!on among the OPEC members for oil sales. In recent years,
pressures have been most severe In the OPEC countries w!th larger
populat!ons --e.g., Iran, Iraq, lndones!a, Nigeria, and Venezuela.
In addition, both Iran and Iraq have .required large Inflows of oil
revenues to maintain their continuing war. Accord!ng to a recent
report <Chase Manhattan Bank, 1984) OPEC as a whole experienced an
account def lcf t of $16.5 bIll !on In 1982 and $21.5 b i Ilion ! n 1983.
As a result of these and other pressures, OPEC has In recent
months experienced difficulty In maintaining Its offTclal
production ceiling of 17.5 million barrels per day. In the last
quarter of 1 983 total OPEC product ron exceeded 19 mil I !on barrels
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per day putting additional pressure on OPEC's official price·
structure. More recently, certain OPEC members have officially or
In effect reduqed their ·prices below the official price levels
Ntgerla, Iran, and Iraq betng cases In point. Pressures on
official OPEC prices from overproduction continue at the time of
this writing. For example, price reductions by Norway and Great
Britain have placed additional pressures on Nigeria which produces
crude of a similar type.
Therefore, since 1981 there have been changes In the structure
of the world oil market that have Impacted. world oil prices.
Reactions by non-OPEC producers and oil demanders to the severe
price Increases of the 1970s forced both reductions In official
OPEC prices and the Imposition of production cell lngs on OPEC
members. As a result, oil revenue reductions have threatened
development programs and In some cases government stab! I tty --for
example, the recent coup In Nigeria. Further, the threat of severe
and sudden oil price escalations resulting from supply disruptions
has diminished as productive capacity far exceeds production.
Although to date the core members of OPEC--mainly Saud! Arabia--
have maintained their base price of $29 per barrel by absorbing the
majority of the necessary production reductions, several OPEC
members continue to cheat In terms of both prices and production
I eve Is. The cohesion of OPEC In the post-1981 era has been shaken
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and w1th that change have come sfgnfftcant reductfons fn world otl
2
pr fees.
Table 2.1 gtves the h·Tstorfcal changes fn the offfcf al prJce of
Saudt Arabfan I Jght crude and Ntgerfan crude from 1973 to the
current tfme perJod. The prfces of other crudes vary dependfng on
thetr respective qual ftfes.
II I. Methodologies Developed to Explafn and Forecast OJI PrJces
The methodologies that have been developed to represent the
functtonfng of the world ott market draw sTgnTffcantly from the
modeler's dfsclpl tne and hfs or her perceptfon of htstory. At the
rfsk of oversfmpl Tftcatton, thls · sectton summarfzes three matn
categories of models that have been used to explatn hfstorfc world
or I prfce changes .and, In some cases, used to forecast future ott
prfce trends. As stated earl fer, an Tndepth account of each model
will not be attempted because of the sheer number of models and
because such an exercfse· would probab I y, for our purposes,
contribute I Tttle to a better understanding of world oil price
forecasts. Rather, models or methodologfes are placed In one of
the three major groups dlscussed above--(1) economic models, (2)
pol !tical models, and (3) economlc-pol Ttlcal combination models.
FTgure 2.1 gfves a graphical representatlon of the disaggregation
~Tstorfcal accounts of developments In the world oil market are
available from numerous sources. See, for example, Deese and Nye
(1981>, Vernon (1976), Landis and Klass (1980), Bohland Russell
(1978), Curlee (1983>, Johany (1980), and Griffin and Teece (1982>.
For more recent assessments of the world ol I market and how recent
trends may signal future changes In the structure of the market,
see, for example, Bohl and Quandt <1984), Horwich and Weimer
(1984), Weyant (1983), Kash, Fox, and Wilbanks (1983), and Curlee
( 1984).
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Table 2.1. Official prices of Saudi Arabian light and
Nigerian crude for selected dates
· (Nomi~al dollars per barrel)
SAUDI LIGHT NIGERIAN
TIME
JANUARY 1973 $2.10 $3.10
DECEP.eER 1973 $3.60 $5.84
JANUARY 1974 $9.60 $12.60
JULY 1974 $10.40 $11.85
JANUARY 1975 $10.46 $11.80
JUNE 1976 $11.51 $12.89
JUNE 1977 $12.70 $14.63
JULY 1978 $12.70 $13.87
JULY 1979 $18.00 $23.49
JULY 1980 $28.00 $37.02
JULY 1981 $32.00 $39.92
JANUARY 1982 $34.00 $36.52
MARCH 1983 $29.00 $30.00
JULY 1984 $29.00 $29.85
SOURCES: AmerJcan Petroleum Institute (1984>
Central Intel! !gence Agency <1984)
Cur I ee ( 1 983 >
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ECONOMIC ----1
MOOELS
OPT I M I ZA Tl ON
17
-f PROFIT MAXIMIZING
COMPETITIVE REVENUE MAXIMIZ lNG
01HER CB JECT IVES
-L ROFIT MAXIMIZING
MONOPOLISTIC
01HER <BJECTIVES
SI~LATION--{CAPACITY DRIVEN
01HER
FO~AL
POLl TICAL MODELS [INFORMAL
[FO~Al
ECONOMIc-POLITICAL -------1 .·
COMBINATION MODELS
INFORMAL
Fig. 2.1 Methodologies to forecast world oil prices
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4
of the three major model lng types Into various subcategories. The
key market and non-market parameters that are hypothesized to
Impact oil pr.lces under each group of methodologies are
subsequently Identified.
A. Economic Models
Economic models of the world oil market can be divided Into two
broad subgroups --optimization models and simulation models. In
optimization models some part of the oil market Is assumed to have
foresight of future market conditions and alters their production
and/or pricing decisions to maximize some given obJective function.
For example, In many models the objective function Is discounted
profits. In simulation models price changes are assumed to be
determined by some set of market or non-market parameters over
which no expl !cit control Is exercised by any subset of the ol I
market. For example, In many simulation models It Is assumed that
world oil prices are determined by the level of excess production
capacity In the OPEC countries or a subset thereof (where the level
of production capacity Is set exogenously>.
1. Optimization Models
The majority of the optimization models assume that OPEC, or a
subset of OPEC, sets production In order to maximize the stream of
discounted profits from the production of their oil reserves. The
selection of the optimal production stream is dependent upon
numerous parameters, the Identification of which requires a brief
review of the economics of depletable resources.
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The depletable resources
semtnal article by Hotel ltng.
19
I tterature Is based on the 1931
In that article Hotel I lng describes
how a resource _owner with zero production costs wll I produce over
time under both competitive and monopol Istre market conditions.
Fran elementary economics It can easily be shown that In a
competitive market price wll I be equal to marginal cost. However.
In the case of a depletable resource the marginal cost of the
resource Is not just the marginal cost of production. In essence
the owner of a depletable resource Is faced with the question of
when to produce the resource. Therefore. In aqdltton to the actual
cost of production. the resource owner must also consider the
opoortyntty cost of producing the resource today at the expense of
not producing the resource tomorrow or. alternatively. producing
tomorrow at the expense of not producing today. In the slmpl lfled
case that Hotel I lng considered where production costs are zero and
resources are fixed. It can be shown that the price of the
depletable resource must rise at the rate of Interest In a
competitive market. Intuitively. this conclusion Is obvious
because In equl I lbrlum the value of the resource In the ground must
be equal to the value of the resource being produced. The owner of
the resource has the option of producing the resource today and
Investing the payment for that resource at the market rate of
Interest. or the owner can leave the resource In the ground and
have the value of the resource Increase at the market rate of
Interest. In equl I lbr!um the resource owner wll I be Indifferent
between the nvo chol ces.
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In the case of a monopoly that controls the resource base, It
can be shown that the monopol 1st <under the same slmpl lfylng
assunptJons gJ~en above-) wrt.l maxlmlze profits when marginal
revenue, which wll I be less than price, rises at the market rate of
Interest. This Is a straightforward extension of the argument for
the competitive case wfth the addftfon of the profit maximizing
condition for monopol lsts --r.e., proffts are maxfmlzed when
marginal revenue Is equal to marginal cost. An Interesting
extension of the monopoly argument shows that. the monopoly
factng a demand function with price elastfclty other than unity
will produce less and price higher In the first time periods of
production and wll I produce more and prfce lower In the later time
periods of productfon as compared to a competitive market. The
monopoly thus pranotes resource conservatl on.
Since Hotel I lng's seminal artfcle, numerous papers have
extended this baste methodology to account for some of the
sfmpl lfylng assumptions made by Hotel I lng --for example, by
Including positive and Increasing resource production costs,
accounting for the posslbl I lty of reserve additions, or Including a
backstop technology or good that would replace the resource In
question at sane backstop price. Depending on which assumptions
are relaxed, the analysis can become quite compl lcated.
Again at the risk of overslmpl lflcatlon, the major parameters
that determine the price of the depletable resource under profit
maximizing conditions can be categorized In a few groups. The
major parameters
( 2) the rate of
of concern are (1) the size of the resource base,
Interest or the discount rate, (3) the backstop
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price; (4) the long-run and short-run price elasticity of demand
and supply of the resource, (5) the rate of world economic growth
and how that g~owth translates Into changes In demand for the
resource, and (6) the speed at which the market adjusts to changes
In market prices and economic activity.
In the mJd 1970s the economics profession general Jy modeled the
world oil market by assuming that OPEC or the core countries within
OPEC--I.e., countries such as Saudi Arabia that have vast and
low-cost reserves as compared to other OPEC countries
effectively cartel !zed the market. It was assumed that by
restricting production these producing countries could In effect
set the price of world oil such that their discounted profits were
maximized. Supposedly, once the oil cartel gained control of the
ol I market In the early 1970s, production and pricing decisions
were made by the producing countries so as to move from the
previous competitive price and production trajectories to the
hlgher-prtced and lower-production trajectories dictated by
monopol Istre profit maximization. Models that fal I Into this
cat~gory Include Pindyck (1978), Kalymon (1975), Cremer and
Weitzman (1976), Gately, Kyle, and Fisher (1977), and Singer
(1982). There are also numerous models that are variations of the
baste monopol lstJc profit maximizing approaches. Hnyll lcza and
Plndyck (1976), Eckbo (1976), and the Salant/ICF Model (see EMF,
1982) address the Inherent problems faced by any cartel that arise
from bargaining over pr!c!ng and production decisions. Because of
varying economic and social concerns In different countries within
the cartel, different members wfl I have different perceptions about
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which production· and price paths are optimal. These models use
game theory to study bargaining within the cartel and Identify side
payments that. ~!¥ be necessary to maintain the cohesion of the
cartel.
In contradiction to the methodologies discussed above, numerous
modelers have argued that one does not necessarily have to assume
that OPEC or a subset of OPEC acts as a monopol lsttc profit
maximizer to explain historic oil price Increases or to forecast
future price trends. MacAvoy (1982) has argued that the prtce
Increases of 1973-74 were unavoidable even under competitive
conditions, given the very tight oil markets that had resulted from
very low historic oil prices.
Some modelers argue that the drastic historical price changes
can be explained within a competitive market In whtch the control
of the resource base shifted from International oil companies to
the oil producing countries. For example, Johany (1980) has argued
that the price Increases of the early 1970s were a natural result
of the transfer of the property rights to ol I from the
multinational oil companies to the producing countries. It can be
argued that the International oil companies made decisions based on
a high dlseount rate previous to the early 1970s because of fears
of expropriation. Once property rights were transferred to the
producing countries, their lower discount rates naturally
translated Into lower levels of production and higher ol I prices.
Another variant of the competitive argument Is based on the
abl I lty of the producing countries to absorb the revenues from
their oil sales. This Is the basic approach taken In Teese (1982>,
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Cremer and SalehJ-Isfahanr (1980>, Mead (1979), and EzzatJ (1976).
These models Jn effect argue for a backward bendtng supply curve
for the major oJI producing countries. The htgher the oil prtce
goes, the less the major producing countries produce because they
have no abtl tty to uti I Jze the Increased revenues. This position
has been criticized on the basts that the producing countries must
assume that oil In the ground ts worth more that "money Jn the
bank." The proponents of this positron counter this crlttcrsm by
arguing that Investments made by producing countries In consumtng
countries are always subject to threats of .expropriation, thus
decreasing the relative value of "money In the bank."
Other variations of the competitive framework also exist.
Bl ltzer, Meeraus, and Stoutzesdyk (1975) argue that the major
producing countries attempt to satisfy the dual objectives of the
maintenance of market share and high current revenues. In the
ETA/Macro Model (see EMF-6, 1982>, the basic objective Is to
maximize the discounted uti I tty of oil consumption In OECD
<Organization of Economic Cooperation and Development) countries.
011 prices are a function of OECD Imports. In the Kennedy-Nehrlng
Model (see EMF-6, 1982) It Is assumed that the competitive non-OPEC
conventional oil producers have
maximize discounted profits.
exogenously.
2. Simulation Models
perfect foresight and act to
OPEC production Is determined
The majority ot models used today to forecast world oil prices
do not employ the optimization approach discussed above. Rather,
simulation models --wnfch do not dfrectly assume that a subset of
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the ol1 market manipulates oil production or prices to satisfy some
obJective--are used to forecast oJI prices and other key oil
market paraneter_s.
These slmul atlon models often empl C¥ a simp I lstlc methodology
In determlnfng world ofl prices--as compared to the optfmlzatfon
approaches discussed
price determination
above. The most common assumption about oil
Is that prices rise when capacity uti I lzatlon
In the OPEC countries rfses above some prescribed level --usually
about 85 percent. At some capacity uti I lzatlon level below 85
percent the price of oil Is assumed to decl lne. The level of OPEC
production capacity fs usually an exogenous Input. Models that
fal I within this category fnclude Gately (1983>, Levy (1974), OMS
<DOE, 1983), OILMAR <see EMF-6, 1982), DRI (1983>~ WOIL <see EMF-6,
1982), Braden <198U, Gately, Kyle, and Fisher (see EW-6, 1982),
OpeconomTcs <see EMF-6. 1982), and OTitank <see EMF-6, 1982).
There are also models that have varlatfons of this baste theme.
For example,
EMF-6, 1 982)
oil companl es
the International Petroleum Exchange <IEP) Model (see
expl fcftly considers the actfons of the multfnattonal
In Its slmulatton. Prices react to changes In the
reserves to productton ratto, production ~osts, and exogenous
royalttes. The IEP fs the only simulation model reviewed In which
the production capacity of OPEC Is not set exogenously.
The key parameters that determine world oil prices are usually
the same In simulation models as In optimization models--I.e.,
oil reserves, Interest rates, backstop price, economic growth,
adjustment rates, and short-run and I ong-run sup pi y and demand·
elastlcltfes. Econometric approaches are used to Identify how
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these parameters --tn addttton to OPEC capacity uttl tzatTon --
have been rel~ted to htstorlcal ott prtce changes. Assumptions
about how thes~ key parameters mav change In future years allows
the modeler to project future otl prtce trends.
Simulation model·s can be crtttclzed on the grounds that the
major determinant of oil prtces --OPEC capacity uti I lzatlon --Is
usu~lly assumed to be exogenous.3 Because of thts
"overslmpl tftcatton;" It can be argued that most slmulatton models
are more adept at forecasting how oil market parameters other than
prtce m~ react to future prtce changes, rather than actually
forecasting world otl prices.
B. Pol lttcal Models
Some modelers have made the lmpl felt assumption that pol tttcal
factors dominate economic criteria In determining the price of oil
In the world market. To some extent It can be assumed that
pol ltlcal goals within the major producing countries are compatible
with wealth maximizing goals. However, It has been argued that
often economic goals--e.g., wealth or revenue maximization--
must be, and are, sacr!ftced to obtain both Internal and external
pol lt!cal objectives. In these cases, It can be argued that formal
or Informal pol lttcal models can best suggest why prices have
changed htstortcally and how ell prices may change In the future.
Two pol !tical models are reviewed briefly here. In Moran
(1982) it Is argued that the pol !tical decisions of Saudi Arabia--
~urlee (forthcoming) argues that the qual lty of the existing
data on current and projected OPEC and non-OPEC production capacity
Is poor, thus placing empirical projections from these models In
question.
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the assumed OPEC leader --wll I have a significant Influence on
future world oJI prices. This Informal model argues that Saudi
ArabJa attempts_to maximize Its own pol ltlcal objectives In Its oil
production decisions, while being constrained by potential hostile
pressures both Internally and externally. Moran presents a
detailed description of the probable pol ltlcal objectives of the
numerous pol ltJcal groups within Saudi Arabia that may have
Influence over future energy pol Icy decisions. Moran thus presents
a model of how differing Internal pol ltlcal objectives--Including
wealth maximization on the part of some power centers Tn Saudi
Arabia--can Interact to determine oil production dectsJons that
do not conform to any of the criteria specified In the economic
models discussed above.
In a more formal model by Saaty and Gholamnezhad (1981) a
methodology called "analytic hierarchies" Is used to formulate a
pol Jtlcal model of the world oil market that takes a more global
perspective. 4 Several pol !tical factors are considered, Including
the degree of lnstabll lty In the Persian Gulf Region, the Intensity
of the Arab-Israel I conflict, and the Increased Influence of the
Soviet Union In the Middle East. Several "econanlc-technologlcal"
factors are also considered within the pol !tical framework,
Including strategies of the consuming countries to Influence oil
consumption, excess-or !-production capacity, the Influence of the
International financial Institutions, oil discovery rates, and
development of alternative energy sources.
4 The "analytic hierarchies" approach Is not explained In great
detail by the authors. For a detailed description of that approach
see Saaty ( 1 980) •
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..
C. Combination Models
In recent years there has been a growing perception among many
modelers of the world oil market that the mechanism by which world
oil prices are determined Is far more campi lcated than that
represented In either economic or pol ltlcal models. This
real lzatlon has .followed the poor predictive abll ltles of both
economic and pol ltlcal model Jng approaches. The frustration felt
by modelers Is best explained by two quotes from one of the
foremost researchers In the field, Robert Ptndyck. Plndyck was one
of the first authors to model OPEC as a monopol Istre wealth
maximizer. Plndyck's confidence In this approach Is reflected In
his 1979 paper. "So far OPEC has done more or less the same thing,
and to the extent that It continues to do so, economic maximization
should provide a reasonable basis for explaining and forecasting
the prf ce of oil" (page 175). However, In a pub I I cat I on by PI ndyck
ln 1~82 he reassesses the worth and predictive capabll !ties of
"models that describe 0 economlcally rational' price formation by
the OPEC cartel" (page 175). "I wIll argue that Improved models
might be useful for examlnlg various theoretical and empirical
Issues In the behavior of ol I markets, but that they are not
needed, and would not be very useful, for predicting world oil
prices" <page 176). "It seems to me that from a theoretical point
of view, models of OPEC oil pricing have reached a practical I lmlt
as tools of analysis. As far as empirical predictions of oil
prices are concerned, some of these models have already exceeded
that I l~lt" <page 179>.
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MOdel lng methodologies have therefore evolved to Incorporate
the real Izatt on that future ol I prIces are very uncertal n and
difficult to p~edtct. On the one hand, some modelers have adopted
stmpl lstlc "rules of thumb" to forecast or I prtces --such as the
assumption used In most stmulatlon models that otl prices are a
function of the degree to which OPEC production capacity Is
uti I lzed.
On the other hand, some modelers have (1) attempted to
Incorporate pol ltlcal factors Into their economic approaches or <2>
have opted for Informal methodologies that lmpl tcttly Include
economic and pol ttlcal criteria. An example of the first type Is a
model by Daly, Griffin, and Steel (1982). In that model OPEC
supply responses are modeled on the basts of actual and potential
reserves, absorptive capacity, and pol lttcal constraints. The
model lng approach --which employs a baste economic approach
constrained by perceived pol !tical real ltles --was used to assess
the stab! I lty of the OPEC cartel given different price paths.
Examples of the second type are Plndyck (1982) and Weyant (1983).
In these papers no formal models are constructed. Rather,
projections of future market conditions are based on Intuitive
judgments based on the authors' perceptions of economic and
pol Jtlcal real Jttes.
I V. Co nc I us l on s
Several conclusions can be drawn from this review of
methodologies designed to explain and forecast world all price
changes. Fl rst, the roots of the various approaches are In the
modelers' dlsclpl lnary perspectives and perceptions of hlstortcal
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even~ In the world oil market. As has been reviewed, the world
oil market has gone through many structural changes In the past two
decades. Oepe~dlng on the time period that Is being modeled, the
particular methodology that Is required mav differ. Second, the
methodologies have evolved during the past decade. This evolution
has come as a result of the poor predictive capabl I ltles of
previous models and because there has been a real lzatton that the
structure of the oil market--Including the relevant players, the
obJective functions of the players, and the abll ttles of the
players to manipulate the market to maximize those obJectives--
has changed. Finally, and most Importantly for our purposes, there
Is no consensus about what methodology should be used to forecast
future world oil prices. To some extent there has been a movement
toward a consensus that prices wll I be determined by both economic
and pol ltlcal factors. Beyond that there Is Jess than complete
agreement about the particular model lng approach that should be
used. However, It Is generally agreed that different model lng
methodologies may
5 forecasts.
lead to significantly different oll price
Whatever the conceptual problems that remain Jn the area of oil
price forecasting, there Is no shortage of price forecasts from
which to choose and evaluate. A review of the recent oll price
forecasts and their underlying assumptions Is the subject of the
next chapter.
5 For more Information on the different methodologies that have
been developed to foreCast world or I prices see, for example,
Sweeney <1983), Bercer <1981 l, Griffin and Teese <1982), and Gately
(1984).
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• 3. WORLD OIL PRICE FORECASTS
I • In tro<luct I on
The purpose of this chapter Is to review and summarize recent
mid-to long-term world oil price forecasts. As was the case In
the previous chapter. the large number of oil market models and
forecasts prevents a detailed discussion of each forecast. Rather,
the various forecasts are summarized and. where possible,
categorized according to the model lng types and major model
parameters discussed In the preceding chapter. Of particular
Interest are the variations In the forecasts caused by changes In
the key parameters. In addition, the forecasts are discussed In
terms of the dates the forecasts were made. A key question Js
whether the most recent oil price forecasts those completed
after the official oil price reduction of 1983 dIffer
slgnlflcantly from earlier forecasts. Because of the l_arge number
of forecasts available. only those completed after 1980 are
considered In this review.
A direct comparison of different price forecasts Is difficult
for several reasons. In many cases only the forecast Is given.
The assumptions about key model parameters. and In some cases the
baste model lng methodology, are often not given. Further. because
the model tng methodologies and assumptions about key parameters
differ so widely In some cases, It Is Impossible to pinpoint why
price forecasts differ.
Because of these problems the available forecasts are grouped
Into three categorres. The first contains what m~ be termed
"expert judgment" in that etten no rigorous mathematical model Is
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32
used fo make the forecasts, or If a formal model Is used the
forecasT Itself has been "flavored" with the forecaster's own
subjective view~ of the market situation. Often these forecasts do
not give specific price projections, but rather project general
prtce trends. This class of forecasts contains predictions based
on the Informal economic-pol ltlcal methodologies described In the
preceding chapter, as wei I as Informal economic and pol ltlcal
models. The second category contains forecasTs thaT are derived
from formal mathematical models. Many forecasts In th r s category
give the basic methodology and values of the major InpuT parameters
used to obtain the forecasts. In some cases the forecasts are
tested for their sensitivities to changes In some of the key
parameters. The third category contains surveys of nunerous
Individuals and groups that periodically make price forecasts.
These forecasts are based on formal mathematical models, expert
judgment, and/or combinations of the two approaches. However, the
surveys do not give sufficient Information about the Inputs to the
Individual forecasts to make detailed comparisons of the Individual
forecasts.
I I. Forecasts Based on Expert Judgment
As Is obvious from the preceding chapter, there are a variety
of approaches to model lng the world oil market. Likewise, there
are numerous positions about future market trends. In this section
the discussion of those positions and forecasts begins with a
review of several quotes from lndlvl.duals well noted In the field:
" ••• ( S) o I ong
of production
direction, and
as the OPEC nations maintain the current system
control, the system ls unstable In the upward
a price hlke Is almost guaranteed at any time
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33
u~less the core nations take active roles toward preventing lt.
For these reasons, I would expect stll I higher (real> prices In
the 1980's despite weak demand" <Adelman, 1982. page 54).
"OPEC will continue to have power over price, especial Jy In the
short term,· and Its power wll I Increase when Its capacity
uti I lzatlon Increases. But, over the longer term, taking ten-
year or twen1y-year averages, OPEC's market power w II I be
constrained by the underlying price-responsiveness of demand
and of non-OPEC supply, for oil and alternative energy sources"
<Gately, 1984. page 1113).
"Considering that OPEC has yet to demonstrate that It has the
wherewithal to del lmlt competitive output expansion, two
decades of constant real prices Is a strong possibility--In
the absence of a supply disruption of significance" <Teece,
1982. page 86).
"In the long run, the desire of the Saudis to avoid the
vul nerabll lty that the mere existence of huge export capabl llty
brings--vulnerability to consumer government pressures to use
It, vulnerabll lty to producer government pressures to Jet It
I le Idle --exercises a great dampening effect on capacity
plans for the kingdom, Irrespective of what huge reserves and
low discount rate might Indicate •••• <T>he analysis of Saudi
decision-making presented here suggests a more pessimistic view
of oil prices <pessimistic from the point of view of energy
consumers> than the economic optimization approach for any
given set of assumptions about supply and demand for energy"
<Moran, 1982. page 116).
"It may be assiiTied •.• that OPEC's pricing policy In the 1980s
wll I be more sensitive to market conditions than It was In the
1970s. If this Is so. OPEC real prices will not rise
significantly over the next nine years. If this assumption Is
wrong oil prices could continue to rise significantly for only
a I lmlted period before the organizations's price structure
wou I d col I apse under the ons I aught of consumer conservatl on and
producer competition" <Uchtblau, 1982. page 143).
"While there remains a high degree of uncertainty about future
world oil prices, most of the uncertainty concerns not whether
real prices will rise, but rather how rapidly they will
Increase. • •• The overal I real price trend wit I be upward"
(James Sweeney as quoted In Daly, Griffin, and Steele, 1982.
page 145).
"Eventual ly, the upward pressure on oil demand caused by
Increases In econanlc activity could more than offset the
downward pressure· resulting from the dwindling adjustment to
the 1979-1980 price Increase. . •• The slack world of I market
me/t! persist tor t-Iro or three more years, but Is unlikely to
I ast much I onger" (Weyant, 1 984. pages 393-394).
"
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"1'he results of this paper suggest that the Iranian pol ftfcal
upheavals of 1 fJ78-79 and the subsequent do ubi I ng of crude of I
prfces mav wei I have defined the I lmlts of OPEC's monopoly
power. A long run real price path significantly greater than
$32 per barrel seems I lkely to evoke large suppl les of
synthetic fuels, coupled with substantial conservation effects
--events which, taken together, make such a price path
unl lkely" <Daly, Griffin, and Steele, 1982. page 173).
"<l>t would probably be reasonable to assign a 2 to 4 percent
real rate of growth to future oil prices as part of a 0 most
I lkely' forecast. But at the same time It must be remembered
that the confidence Interval around that forecast Is extremely
wide, perhaps as large as 50 to 100 percent. What should
really matter In terms of the decision of energy producers and
energy consumers Is not the 0 best guess' forecast, but the fact
that the uncertainty around that forecast Is considerable"
<PI ndyck, 1982. page 179).
"<T>he authors In this volume bel leva that the world economy
has by no means fully responded to the 1973-74 price shock, let
alone the 1979 shock" <Griffin and Teece, 1982, page 208>.
"<T>he target revenue model suggests that substantial downward
price movements are I fkely In the event of a prolonged soft
market" <Griffin and Teece, 1982. page 211).
"The consensus of the authors appears to be that If a large
price hike occurs In response to some pol ltfcal disruption, It
wll I not be sustainable In the long run, unless such pol ftlcal
upheavals permanently take appreciable capacity out of
production" <Grlffln and Teece, 1982. page 212).
"At most, after 1990 I would expect a real Increase of
percent per year ln oil prices after the $34 price Is attained"
<Netschert, 1983, page 141 >.
"If OPEC operates as a revenue-max! ml zing cartel, It w !II I ower
nominal oll prlces to the $25--29/bbl range and allow Inflation
to reduce real oll prl ces l n 1986 to the $20-23/bbl range"
( Roumasset, Isaak, and Fesh arak I, 1 983, page 1 93 > •
"Unllkethe sltuatlonln the 1970s, when the Interest of
exporting and Importing countries seemed to be diametrically
opposed, lt now appears that OPEC and the Importing countries
will both lose If prlces rlse. • •• Consequently, It ls
reasonable to Imagine that most OPEC members wll I recognize
thelr sel f-lnterest ln stable prlces In coming years" <Bohl and
Quandt, 1984, page 18).
"If these models and scenarios correctly
futures, we can expect the real price of
rernal n stagnant tor several years and
significantly ... " <EMF-6, 1982. page 92).
represent world of I
ol I to decl lne or
then to rise
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4
"Whether fran operations wlthfn OPEC or those In an open
market, world crude otl prtce should remain constant or
increase at most by one or two percentage points each year
during the t980s" <MacAvoy, 1982. page 78).
"The OPEC countries ••• --Algerta, Indonesia, Nigeria,
Venezuela, and Ecuador --wll I advocate large oil price
Increases during the 1980s because of their need for oil
revenues and because of their I lmlted role as exporters In the
long term. • •• Saudi Arabia and UAE have an economic Incentive
to block Increases--which would bring the oil price above •••
the price at which substitutes to OPEC oil wll I start being
Introduced ••• or the price at which the value of OPEC's
ftnanclal surpluses wll I begin to deprectate ••• " <Aperjls,
1982. page 125>.
While the revtew of these forecasts by tndustry experts does
not lead to any deflntte conclusions, It does suggest a movement
toward a consensus on several potnts. First, the predominant view
Is that real oil prices wll I not Increase or decrease significantly
durrng the remaInder of the t 980s. In the 1990s and beyond real
prices are expected to Increase moderately, but should not be
Subject to the drastic price Increases observed In the 1 970s.
Drastic price jumps are not seen to be In the Interest of either
oil const.mers or OPEC. Second, the prevail tng vtew Is that OPEC
wll I continue to maintain a significant degree of control over the
oil market, but to a lesser
restraint on OPEC's power
adjustments of oil consumers
degree than rn the 1970s. This
will result from the continuing
and non-OPEC oil producers to the
drasttc price escalations of the 1970s. Thlrd, there Is a general
consensus that the Impacts of supply disruption, such as those of
the 1970s, may result In short-term price jumps, but those jumps
would probably not be maintainable over the long run. Finally,
·while price forecasts do not diverge as widely as they have In the
E
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36
past,• there Is stll I a recognition and a warning that world oil
price forecasts contain a great deal of uncertainty.
Ill. Forecasts Based on Formal Models
In this section numerous price forecasts that have resulted
from formal mathematical models are reviewed. The sources of these
forecasts vary widely --from academic Institutions, to government
agencies, to private firms. In addition, the forecasts vary Tn
terms of the year they were publIshed and In terms of the model lng
methodology used. At I east one sample of each of the formal
methodologies discussed In the previous chapter Is represented. In
some cases only one observatTon --I.e., one forecast --was
available. In other cases there are as many as four observattons
from a particular model.
The review of forecasts presented here certainly does not
represent alI available forecasts. The review does, however, give
a sampl lng of different model Tng types, forecast years, and
forecasting Institutions. Further, this review does not lead to
definitive statements about how and why forecasts vary due to
differences In underlying assumptions and parameter specifications.
Some broader general conclusions can, hOttever, be drawn. In the
following subsection the forecasts are presented and discussed In
terms of their general model lng methodology, date of publ lcatlon,
and, where possible, the specific model used. That review Is
followed by a discussion of how changes In some of the key model lng
param.eters have been shown to Impact some of the forecasts.
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A. T~ Forecasts
To help tn our assessment of the forecasts, the price
proJections are arranged. accordtng to dtfferent parameters In
different tables. Table 3.1 presents the forecasts arranged by the
year the forecast was publ Jshed. Whtle the prtce projecttons are
gtven Jn terms of constant dol Jars for each lndtvldual forecast--
as gtven Jn the referenced source--the dtfferent forecasts have
not been adJusted to reflect a base-year constant dol Iars In this
table. In Table 3.2 the forecasts are agatn arranged by year
publ lshed, but alI prtce projections have been converted to
constant 1981 dol lars.6 Forecasts are arranged by model Jng type
and by the organization maktng the forecasts Jn Tables 3.3 and 3.4,
respecttvel y. In Table 3.5 the forecasts are arranged by thefr
projected 1990 price level.
An overview Of al 1 the forecasts shows that oil prices--In
constant 1981 dol Jars--are projected to be between $17.12 and
$50.73 per barrel In 1985 Cwlth a medl an of $25.46), between $19.56
and $64.00 per barrel In 1990 <with a median of $36.65), between
$24.57 and $59.62 dollars per barrel In 1995 (with a median of
6 AI I prices have been adjusted by the U.S. GNP deflator. While
the use of a U.S. price deflator Is satisfactory to adjust oil
prices to a base year from a U.S. perspective, It m~ not be
appropriate Jn adjusting world ol I prices to a base year. Because
of significant changes In the exchange rates among different
currencies, It Is not clear that adjusting prices by a U.S.
defl~tor wfl I give accurate real price changes for the world
market. For example, Huntington (1984) has argued that while the
real price of ol I went down In the U.S. between 1981 and 1982. the
real price went up In several other OECD countries--e.g., Italy,
Japan, France, and the United Kingdom --due to exchange rate
varl at! ons.
F 38
[
Table 3.1. A sumary of oil price forecasts
[ arnnged by year Jli> 1 i shed
.. ear
t Organization SClln:e Date of r-txtel Constant
ar tobdel of Mxi!l SCllrce TyPe 1335 19!ll 1995 am 3)10 am Dollars
r tFE OOE (FE ].gl) NA 43 198)
!XE~Aa OOE,()PPA 1981 ~ 46 55 74 1982
[" MITRE a MrmE 1981 ~ 76 1982
Sa~ & Ghll. Sa~ & Gtol. 1~1 Political 41.06 44.86
[ Bali Boh1 15S2 Caroi nation al.2 1972
ETA ~ro EW~ 1982 c~ Opt g).6 00.2 64.1 68.9 ~l r ··' Kemec:tf-Nehri ng EW~ 1982 c~ Opt ~.8 n.5 71.4 71.4 ~1
r: Salant ICF EW~ 1982 Mom Opt 55.5 71.3 ~.8 l.C6.l a31
{___; \01 Marshall a ·1982 Mom Opt 31.53 35.91 ~.85 42.17 56.66 1982
[ Fosterl Foster ~2 NA 34 ~ 49 1982
9-CAa ~ ~2 NA 53.8 66.5 103.4 1982
L Gately EM='~ 1~2 Sirrulation 52.9 71.7 71.3 93.8 l.Sl31
c IPE EM='-6 1~2 Sirrulation 37.2 54.6 l.Sl31
EM="-6 1982 Sirrulation 64 ffi.8 12).2 127.3 l.Sl31 OilJ.M
c OILTPH< EM="-6 1982 Sirrulation 63 92.1 129.7 152.3 l.Sl31
()1S EM="-6 1982 Sirrulation 46.1 l.Sl31
E Opeconantcs EW~ 1982 Sirrulation ~.7 41.5 1981
c \tOIL EM='~. ~2 Sirrulation 47.8 69.6 81.8 69.1 l.Sl31
Singerb Singer ~Mom Opt 17.8 21.9 Zl.4 32.2 1.98)
f 9-[AC ·~ ~NA Zfi.3 'l/.09 32.34 37.5 :D.39 64.48 1.983
L
Texacod Texaco I.Se3 NA Z1 (B 29 ]) 1982
li OeYarajan et al Devar. et al l9i3 Si111Jlat1Cil 32.8
b llU 101 [)U ~ Si111JlatiCil ]),09 li.1 44.12 51 l.Sl31
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4
Table 3.1. (continued)
Year
Organizatioo sa..rce ~te of r.tldel Constant
a-r.tldel of tb21 sa..rce TtE! ~ 1.9'}) 1995 2lX) 2)10 aJaJ Dollars
CMS Hig, EIA 1!83 SintJlation 34 48 ~
CMi Lew EIA lSlO SintJlation 21 28 1!E2
CMi Mid EIA lSJD SintJlation 25 '5I ~
RtUI8Sset et al Rans et al 1~ sintJlation 17.12 19.56 25.47 1$1
~c 9£.A ~NA ai.J 'l/.9 32.5 40 Ei) 8) 1$3
~rd llU ~ SintJlation 'll.S 25 28 1$4
CMi Hig, EIA 1984 SintJlation ]).53 45.64 65.89 1$3'
CMi Hi g, Draft EIA ~ SintJlation ]) 40 55 l984
CMi Lew EIA 1984 SintJlation 22.44 29.16 36.54 1$3
CMS Lew Draft EIA l984 S1ntJlation a4 25 ]) l984
()f) Mid EIA ~ SintJlation ;!;.52 36.65 !il.49 1983
CMi Mid Draft EIA 1984 SintJlation 'l/.92 l) 40 1984
~ reported in Foster, Burton and Haf1]eter (1~).
bsinger Jllints art ttlat these are rot oil price forecasts, rut rather reflect tile prices that 'fOJld t:e
cha~ I?( a profit JTBXinrizing oil cartel.
CAs reported in Alaska Po.rEr ~rizy (1~).
drnterpreted fran a graphical ~tion.
[J
[ 4 40
[ Table 3.2. A sunnary of oil price forecasts arranged ~
-· year ~1 ished
(In coostant 1~1 oollars)
0 -Year
Organization Soorce Date of r.tx!el Constant
or~l or Mn!l Soorce Type 1~ 19ClJ 1995 ;m) a:no (!)20 Do 11 a rs
[ OPE OOE CPE lE8l ~ 47.02 1981
[ llE!UPPAa OOE;1JPPA 1981 ~ 43.37 51.86 69.77 1981
MITRE a MITRE 1981 ~ 71.66 1981
[ Satzy & Ghol. Satt;y & Ghol. 1~1 Political 41.()) 44.86 1981
Bohi !3001 1$2 Cami nation 39.41 1981
B ETA Macro tW~ 1982 CCI'fl) Opt 5J.6 00.2 64.1 68.9 1981
c Kennec:tf-Nehri ng EW~ 1~2 CClll' Opt 56.8 77.5 71.4 71.4 1981
LJ Salant ICF . EM='~ 1~2 Mooo Opt 55.5 71.3 a3.8 1()).1 1981
[ ~ r.Brshalla 1982 Mono 0 pt 29.73 33.86 36.63 39.76 53.43 1981
Fostera Foster 1982 ~ 32.()) 35.83 46.2 1981
b SI-CA a 9-I:A 1982 ~ :D.73 62.7 97.5 1981
c Gately EM='~ 1982 Sirrulation 52.9 71.7 71.3 93.8 1981
IPE EM='-6 1982 Sirrulation 37.2 54.6 1981
E OilJt14R EW-6 1982 Sirrulation 64 86.8 1a).2 127.3 1981
OILT-W< EW-6 1982 Sirrulation 63 92.1 129.7 152.3 1981
ECM) E}f'-6 1982 Sirrulation 46.1 1981
Opeconanics EW-6 1982 Sirrulation 39.7 41.5 1981 c \tOIL EM='~ 1982 Sirrulation 47.8 69.6 81.8 69.1 1981
r: Singerb Singer 1933 r-1ono opt 19.46 23.95 29.96 35.21 1981
lJ SI-CAC 9-I:A 1983 ~~ 23.79 24.51 29.26 33.93 45.59 58.35 1981
b Texacod Texaco l983 ~ 3.46 26.4 27.34 28.29 1981
Devarajan et al Devar. et al 1~ Sirruhtion lL93 1981 c llU '.a1 llU 1~ Sirrulation ]).09 l:i.l 44.12 51 1981
L
E
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Organization
or r'odel
~ Hig,
~ LQ!i
().15 Mid
4
Soorce
or r.txtel
EIA
EIA
EIA
[
RWIBSset et al RWIBS et al
51-f.AC 9£A
[J ~td
()15 Lew
(J (M) Mfd
~ ()15 Hig,
[ ()15 LQ!i Draft c CM5 Mid Draft
eMS Hig, Draft c
~
EIA
EIA
EIA ·
EIA
EIA
EIA
41
Table 3.2. (continued)
Date of r-txte 1
Source T~
lS63 Sinulation
lS63 Sinulation
lS63 Sinulation
1~ sinulation
]g34 ~
]g34 Sinulation
1$4. Sinulation
1.934 Sirrulation
l934 Sinulation
]g34 Sinulation
1934 Sinulation
1~ SiTTUlation
1$5
32.(l;
19.8
Z3.57
17.12
Z3.79
~.13
aJ.31
Z3.99
ZJ .62
2l.(l;
~.5
ai.33
ml
45.26
ai.4
34.88
19.56
25.25
21.94
26.39
33.17
41.3
21.94
26.33
35.11
aAs reported in Foster, Burton and Ha~ter ( 1933).
~ ~~c". ~" Year
Constant
1995 am ana a::Ja:l Dollars
25.47
~ ~.19 ~-~ n.~
24.57
33.(l;
45.69
59.62
26.32
35.11
48.27
~1
1$1
1~1
1$1
~1
~1
~1
~1
~1
~1
~1
1981
e
E
bsinger jX)ints rut that these are oot oil price forecasts, M rather reflect tre prices that YGJld t:e
charged !?( a profit ITBXimizing oil cartel.
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cAs reported in A 1 aska P<W!r Authority ( 1~) •
drnterpreted fran a ~ical presentation.
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43
Table-3.3. (continued)
Date of MJdel
Year
Constant Fiorganization
U or r.tldel or MJdel Source T1E! 1985 ].9CJ) 1995 am ana aJ20 Do 11 ars
PMITREb
--'Fosterb
[Sii'Ab
MITRE
Foster
9£.A
1$1 ~
1$2 ~
1$2 ~
32.()) 35.83
:D.73 62.7
71.66
46.2
97.5
Sli'Ac 9£.A NO~ 23.79 24.51 29.26 33.93 45.59 58.35
Crexacoa
BS!i'Ac ~lant IQ='
['D1 .
LJ
Singerd
[lA tlacro
['<~-Nehring
Bdli
Texaco 1$3 NA
9£.A 1$4 ~
E}tf'..(i 1$2 Mooo Opt
tlarshalla 1$2 Moro Opt
.
Singer 1$3 rr1ono Opt
a.f"..() 1$2 COfll Opt
a.f"..() 1se2 Call> Opt
Sohi 1332 Cootir~ation
arnterpreted fran a graphical presentation.
25.46
23.79
29.73
19.46
39.41
0'
e bAs reported in Foster, Burton and Harppeter ( 1983).
cAs reported in Alaska Pa..er Authorit;y (1~).
ai.4 'l/.34 28.29
25.25 29 36.19 54.29 72.39
55.5 71.3 ffi.8 1()).1
33.86 36.63 39.76 53.43
23.95 29.96 35.21
5),6 00.2 64.1 68.9
56.8 n.s 71.4 71.4
1331
1331
1331
1$1
~1
~1
1981
1981
1981
1981
~1
~1
h dsinger !))ints wt that ttlese are rot oil price forecasts, rut rather reflect the prices tilat VOJld re
charged ~ a profit rraximizing oil cartel. c .
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44
[ .
Table 3.4. A SU11Tilry of oil price forecasts an-anged by
t organization making forecast
(In coostant 1~1 oollars)
/ Year
[ Organization Soorce Date of r.'odel Constant
or ~t>de 1 • or r-'ode 1 Soorce Type 1~ 19Cll 1.995 am ana ::.U20 Dollars
[ B<tti Sohi 1932 Camination 39.41 1981
Devarajan et al Devar.et al ~ Sinulation ll.93 1981
[ aE;OPPAa OOEA:lPPA 1$1 ~ 43.37 51.86 69.77 1981
!:Rl 101 [Rl ~ Sinulation l).09 36.1 44.12 51 1$1.
E [Rib [Rl 1934 Sinulation 24.13 21.94 24.57 1981
r: ETA ft4acro EJ.F-6 1932 C<Jtl) Opt Sl.6 00.2 64.1 68.9 1$1
(_; Fostsera Foster 1982· ~ 32.()) 35.83 46.2 1981
[ Gately a.f'-6 l982 Sinulation 52.9 71.7 71.3 93.8 1981
IPE EM='~ 1~2 Sinulation 37.2 54.6 1981
[ Kennectt-Nehri ng EM='~ 1~2 C<Jtl) Opt 56.8 77.5 71.4 71.4 1981
c MITRE a MITRE 1931 ~ 71.66 1981
OilJ."AA tw~ l982 Sirrulation 64 86.8 1ZD.2 127.3 1981
e OILT..aN< tw~ 1932 Sirrulation 63 92.1 129.7 152.3 1981
1981 (M) tw~ 1932 Sirrulation 46.1
t (M) Hi(jl EIA 1SW Sirrulation 32.()) 45.26 1981
(M) Hitjl EIA 1934 Sirrulation l/.62 41.3 59.62 1981 c CMS Hi(jl Draft EIA 1934 Sirrulation 26.33 35.11 48.27 1981
r~ CMS L~ . EIA 1.933 Sirrulation 19.8 a5.4 l981
u
(M) L~ EIA 1934 Sirruhtion ::.U.31 a5.39 33.()5 1981
[ CMS L~ Draft EIA 1934 Sirrulation 21.()5 21.94 26.32 1981
CMS Mid EIA 1.933 SirTlllation 23.57 34.fe 1981
L CMS Mid EIA 1934 SirTlllation 23.99 33.17 45.69 1981
L CMS ~'i d Draft EIA 1934 Sirrulation 24.5 26.33 35.11 1981
[
[
L
r:-.-
4
Soorce
45
Table 3.4. (contii1Jed)
Date of t-b:iel
Year
Constant Organization
cr~l
LOPE OOE
or r.tJdel Soorce T~ 1~ l.gg) 1995 am a:no a:J20 Do 11 ars
[ OpecoriCJlrics
Rrumsset et al
[ Sa1ant ICF
[l Satty & Ghol.
L SH:Aa
rs;[AC
l.__;
51-[AC
[ Singerd
[T~r:P
IDIL
c}l)M
CPE
EJ.F-6
RCUTBS et a1
EJ.F-6
Satty & Ghol.
9-CA
9-CA
9-CA
Singer
Texaco
EJ.F-6
tAarsha1la
J3D NA
1~2 Sirru1ation
1~ Sirru1ation
~2 Mono Opt
1~1 Political
~2NA
~NA
~NA
1~ Mono Opt
~NA
1~2 Sirrulation
1~2 Mono Opt
47.02
39.7
17.12 19.56
41.5
25.47
55.5 71.3 88.8 1C6.1
4l.C6 44.86'
~.73 62.7 97.5
23.79 24.51 . 29.26 33.93 45.59 58.35
23.79 25.25 29 36.19 54.29 72.39
t9.46 23.95 29.96 35.21
25.46 26.4 ZJ.34 28.29
47.8 69.6 81.8 69.1
29.73 33.86 36.63 39.76 53.43
0
t
aAs reported in Foster, 8urton and Hanpeter ( 1~).
brnterpreted finln a graphical presentation.
cAs reported in Alaska Pa...er Authorit;y (1~).
1~1
1981
1981
1981
1981
1981
1981
1981
1~1
1981
1981
1981
clsin~r ~:Qints rut that these are rot oil price forecasts, rut rather reflect the prices tilat v.oold oo
ccha~ by a profit IT6Xinrizing oil cartel.
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r Table 3.5: A Sllmllry of oil price forecasts amnged ~ LJ
D
projected l,gg) price level
(In CDlStant 1~1 oollars)
Year
rOrgani zation Soorce Date of ~1 Constant
or~l or r.txEl Srurce T:tpe ~ ].9g) 1995 a:m 2)10 2J20 Dollars
cMITRE· MITRE ~1 NA 71.66 1$1
B<tti 1.Se2 Camination 39.41 1$1 -~B<tti
[Devarajan et al Devar. et al 1983 Sirrulation 3).93 1$1
RQIIBSset et al RQIIBS et al 1983 Sirrulation 17.12 19.56 25.47 1$1
p~rb llU ~ Sirrulation 24.13 21.94 24.57 1$1
CMS L~ Draft EIA ~ Sirrulation 21.()) 21.94 26.32 1$1
[s;ng:rC Singer ~ MoroOpt 19.46 23.95 29.96 35.21 1$1
[9-f.Ad 9-rA 1983 ~ Z3.79 24.51 29.26 33.93 45.59 58.35 1$1
51-f.Ad 9-rA 1934 NA Z3.79 25.25 29 36.19 54.29 72.39 1981
[J.1S Mid Draft EIA 1934 Sirrulation 24.5 ~.33 35.11 1981
CMS L~ EIA 1934 Sirrulation 2J.31 ~.39 33.C6 1981
C~exacab Texaco 1~~ 25.46 ~.4 27.34 a3.29 1981
r:: EIA 1~ Sirrulation 19.8 ~.4 1981
EIA 1934 Sirrulation Z3.99 33.17 45.69 1981
[l)f M!rshalla 1~2 Mono Opt 29.73 33.86 36.63 39.76 53.43 1981
(}1S Mid EIA 1983 Sirrulation Z3.57 34.88 1~1
eMS Hiljl Draft EIA 1934 Sirrulation ~.33 35.11 48.27 1981
y5osterd Foster 1982 ~ 32.()) 35.83 46.2 1981
~I 'Of au l983 Sirrul~tion 1).09 -36.1 44.12 51 1981
[iPE t}f"-6 1982 Sirrul1tion 37.2 54.6 1981
Opecooorri cs 8-F-6 1982 Sirru l-3tion ~.7 41.5 1981
L~ Hi~ EIA l£&l Sirru 1 at ion ll.62 41.3 59.62 1981
(atzy & Ghol. Satt;y & Gho 1. 1~1 Political 41.()5 44.86 1981
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[
Table 3.5. (cootirued)
C Organization
Year
Source Date of r.tldel Constant
or r.tldel or~l SaJrce Type 1S65 19.}) 1995 am ana aJaJ Dollars
L (M) Hi!Jt EIA 1$3 Sinulation 32.(); 45.26 1981
[(M) EM="-6 1$2 Sinulation 46.1 1981
' OPE rDE CPE ~NA 47.02 1981
[ WHL EM="-6 1~2 Sinulation 47.8 69.6 81.8 69.1 1331
ETA r-'acro EM="-6 1~2 Call) Opt 5).6 00.2 64.1 68.9 1981 c lll:AJPPAa rDEAJPPA 1$1 NA 43.37 51.86 69.n 1331
Gately EM="-6 1~2 Sinulation 52.9 71.7 71.3 93.8 1331 c Salant ICF t}f"-6 1~2 ~-1ono Opt 55.5 71.3 83.8 ll)).1 1331 .
[ Kerlne<tf-Nehri ng fW-6 1~2 Call) Opt :x5.8 n.5 71.4 71.4 1981
Si-[Ad SI-CA 1~2 ~JA 5).73 62.7 ' 97.5 1981
[ OILT.AU< EM='-6 19:s2 Sinulation 63 92.1 129.7 152.3 1981
OilJAAA EM="-6 1982 Sinulation 64 ffi.8 laJ.2 127.3 1981 c ._
0 aAs reported in Foster, 3urton and Ha~ter ( 1983}.
brnteJ'l)reted fran a graphical presentation.
r cs;nger !X)ints <lit that these ar not all price forecasts, rut rather reflect the prices that YOJld ~
C charged ~ a profit rraximizing oil cartel. c ~s reported in Alaska Power Auti1ority ( 1~}.
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48
$33.06">, between $25.47 and $97.50 per barrel In 2000 (wIth a
median of $62.10), between $45.59 and $129.70 per barrel In 2010
(with a median of $71.40), and between $53.43 and $152.30 per
barrel In 2020 (with a medl an of $71.90). Caution must, however,
be advIsed In I nterpretl ng these resuf ts. AI I forecasts do not
give price projections for the same time per!ods. General fy, fewer
projections are available for years further Into the future.
Some general conclusions can, however, be drawn from the review
of these forecasts. First, price forecasts do not seem to vary
consistently according to model lng type. Projections vary
significantly within the model lng types for which several forecasts
are given. For example, projections for 1990 using simulation
models range from a high of $64.00 per barrel for a 1982 forecast
to a I ow of $19.56 per barrel for a 1 983 forecast. Further,
forecasts published dur!l'"lg 1982 as a result of the Energy Modeling
Forum's EMF-6 report en world oil prices--ir. which the s!mul~tlon
approach was used--varied between $37.20 and $64.00 per barrel.
It is interesting to note, however, that the forecasts based on
monopol istlc optimization tend to be relatively lower--especlally
in the rr:cre distant future--than forecasts usirg ccrn~etitive
optimization and slmul~tlon models. The reader r.1c-y· recall fran the
previous chapter tr.at economic theory suggests that although a
monopoly w!f I set pr:ces higher than competition wculc dictate at
the beg!nning of the production of the fixed resource, a monopoly
or a cartel will eventLally set prrces lower thaf"l wculc exist if"l a
competitive market as resources are depleted.
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4 Second, there does appear to be a slgnlffcant difference
between forecasts publ fshed during the 1981-82 and 1983-84 time
periods. A rev_few of Tables 3.2 and 3.5 shows that forecasts have
In general been revised downward In the 1983-84 tfme period. Table
3.4 shows how forecasts from specfffc models have changed over
tfme. For example, base projections publ !shed by Data Resources,
Inc. In 1984 were much lower than those publ !shed In 1983 --from
$44.12 down to $24.57 dol Iars per barrel for 1995. Forecasts
publIshed by the Energy Information Administration (within the U.S.
Department of Energy> using the 0!1 Market Simulation <OMS) Model
have been
of 1 983.
$34.88 per
revised downward since the official. OPEC price reduction
EIA's medium case projections for 1990 have changed from
7 barrel In 1983 to $26.33 per barrel In 1984. The high
and low EIA forecasts have also-been revised downward from $45.26
to $35.11 per barrel and from $26.40 to $21.94 per barrel,
respectIvely. As can be seen from Table 3.4, projections by
Sherman H. Clark Associates (SHCA) have been lowered drastlcal ly
since 1982. For example, SHCA projected In 1982 that ol I prrces
would be $97.50 per barrel In 2000. In 1984 that projection has
been revised downward to $36.19 per barrel in constant 1981
dollars.
~ote that the ~ost recent EIA forecast given In the tables Is a
draft and thus cannot be consrcered an offlc!al EIA forecast.
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s. Sensitivities of Forecasts to Changes In Key Parameters
There Is not sufficient detail given In the above d!scussed
forecasts to c~plete a ·formal sensitivity study of the results.
Ideally, one would like to test the sensitivities of different
model lng types to changes In the key parameters. However, In most
cases the publ !shed forecasts give only minimal Information about
the key parameter values. Many parameter values are not given.
Further, In many publ !cations there are several scenarios
presented; however, the different scenarios represent changes In
several parameters, not just one. It Is therefore not possible to
determine how the forecasts vary because of a change In a
part I cuI ar parameter.
As a result, this subsection wll I concentrate only on the
publ !cations that have reported how forecasts from a particular
model or a group of models vary due to changes In the major
parameters. Two publications are the focus cf this subsection
the Energy Model lng Forum's EM="-6 report and a book edited by
Griffin and Teece (1982). The discussion Is further limited to the
majcr parameters that Influence the forecasts of optimization and
simulation models d!scussed In Chapter 2 --i.e., ol I cemand price
elasticity, GNP growth, o!l cemand income elasticity, Interest
rates, the backstop price, and the level of CPEC production
capacity. Table 3.6 gives the different scenar!cs used in the E~1F-
6 st~.;dy. Figure 3.1 sl.ll1mar~zes how the ell price forecasts for
2000 from each of the ten simulation and optlmizatiqn models used
In that study var:ed, frven the ma~cr parameter changes as
repres~nted by the c: tferent scenarrcs.
c 51
c 4 Table 3.6 Scenario ~ons used in the EW-6 s111ctf
....;
[ Dal8ld L~run Eccnmfc CFEC
Scenario RecU:tf~ Prillllry Ener'qf Grotth Proctlction Noncalvet'ltiona 1
Oerand Elast1c1zy Rate capac;zy Energy $t.q) ly
c 1. Referen:e None 011: -0.6, See 34 r+1ll $60/bb 1 : 1 i mf ted
erergy: -0.4 Table A-3 CJ,Jantities
[ {Appendix B)
2. Oil Deland 2) f+8)
[ ReclJctlon by:ml
3. LQII De1and ~.375,
[ Elast1c1zy ~.25
4. Oil Oel1llnd
ReclJctlm-c LQII Oe1a1d 2) f+8) -0.375,
Elast1c1zy by 2)3) -0.25
r 5. LQII Ecancmfc 2/3of
Gmrrth referera L rates
[ 6. Restricted m of refenn::e
Backstcp ' limits
[ 7. Disrwtion ~ r+1ll
fran
1~ on
c 8. Technological $40/bb 1 ; i ocreased
Breakthf'Cll41 limits
l 9. Disruption-~ t+Bl
LQII Dellll1d ~.375, fran
Elasticizy ~.25 1985 on c 10. Optinrist1c aJ r+Bl ~<ilal $40/bb 1 ; increased
by2l3l ircrease limits
c 40 t+Bl
in 1987
11. Disrwtion-aJ ftMJ) 24 t+BJ r 0 i1 DE!IIV1d by ~aJ fran
u ReclJctlon 1$5 on
t 12. Hi~ Oil Price
c SOJrce: EJof-6 (1982, page 102)
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sceaar1o
1. Reference
2. 011 DU&n4 Reductian
3. Lav Deulld
Ehat1c1ty
4. 011 Deulld Recluotian-
Low D-£laat1c1tY
5. Low Econo&I.C GI'Oiftb
6. _Rest~1cted Baclcatop
7. D1a~upt1on
8. TeohiiOlOClcal
B~eal<tMoucb
9, D1a~upt1oa-Lov
Deund Elaat1o1ty
10. Opt1&1at1c
11. D1arupt1on-01l •
Deund Reduction
0 20
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CGI\ISl
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8 I C 0 AI G W S IC
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£ 0
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11oaela: G : Gately, I • lEES-OMS, C • IPE, A • ETA-MACRO, IC • Konnedy-Neftr1nc,
0 • OILMAR, E: OILTAIIIC, W • \IOIL, S • Sahnt-ICF, 8 • Opecono.ic.s
1-0 160
c £
& 0
A
Note: For all IIIQC1ela otner tnan tEES-OMS and IPE, the ave~ap or prtcea oetw"n 1995 and 2005 1s given. For
IEES-OHS, the 1995 prt ce u presented; ror IPE, averages between 1995 and 2000 are presented. Several
projections are nigher t.nan 1160/bbl anel thu.3 do not appear above. These include: ror the low deund
elut1c1ty scenario, Kennody-Heftrtnc ($175) and OILM.U ($177); ror the aurupUoa-low <1-.!d elut1c1ty
acenar1o, OILTAJIIC ($184), IPI ($198), hnnody-Neftr1nc ($217), &na OIUIAR ($-17).
Fig. 3.1. Sensitivities of EMF-6 price forecasts.
Source: EMF-6 (1982, page 49)
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1. Long-Run 011 Prtce Elasticity of Demand
There has long been a controversy about the appropriate long-
run oil price ~lastlclty· to use In oil price forecasts. In the
EMF-6 study a base elasticity of -0.6 was used. In other scenarios
the price elasticity was reduced to -0.375. As can be seen from
Figure 3.1. this change resulted, as we might expect, In large
Increases In the forecasts for the year 2000. In the base case.
prices range from about $40 to $95 per barrel In constant 1981
dol Iars. The price elasticity reduction Increases that range to
about $45 to $145 per barrel.
The base price elasticity used In most papers In Griffin and
Teece <1982) Is significantly higher at about -0.75. Daly,
Griffin, and Steele <1982) study the lmpl fcatlons of a -0.365
demand elasticity on OPEC's stabll lty and conclude that under the
lower elasticity --and given a $32 real price path --OPEC's
production Increases to 38.3 mil I Jon barrels per day In 2000 as
compared to 22.2 at the higher elasticity. OPEC's stab! I lty Is
thus more stable at the lower elasticity and therefore higher oil
price paths are more I lkely.
In a sensitivity study by Salant (1982) the pr!ce elasticity of
demand was reduced from -0.5 to -0.4 with the result that the
optimal price for a profit maximizing cartel Increases by 7.6% In
1980. The price difference between the two paths Increases
gradually over the entire forecasted period --1980 to 2050 --
given the elasticity reduction.
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2 ~ G~P Growth
There appears to be less dtsagreement about the ass~.med rate of
GNP growth. T~e EMF-6 study assumed annual GNP growth rates of
approximately 3J In the OECO countrres and 5J In the oll-tmportlng
developing countries through the year 2000. Other forecasts used
approximately the same rates. For example, Data Resources, Inc.
used a GNP growth rate of about 3% for seven of the large OECO
countries tn Its Autumn 1984 publ tcatlon. The Energy Information
Admtnlstratron also used a 3% growth ftgure rn Its May 1984
pub I tcatl on. The papers In Grlfftn and Teece (1982) assume OECO
economic actlvtty wll I grow at between 3J and 3.5% between now and
the year 2000. During recent decades real GNP growth has been
about 4%, with stgnlflcantly faster growth tn the 1960s as compared
to the 1970s. There may be more divergence on how GNP growth wll I
translate Into tncreased o!l consumption. In most of the models
used In the EMF-6 study, It was assumed that growth In oil demand
would be roughly proportional to the growth In GNP. In the papers
In Griffin and Teece !twas assumed that roughly a 1% Increase In
8 GNP wll I result In a 0.75% Increase In oil demand.
In the EMF-6 study .the base case economic growth was reduced by
33% In one scenario. Flgure 3.1 Indicates that most of the
8 The lmpl !cations of economic growth wll I differ depending on
the type of country In which the growth occurs. Most forecast that
growth In less developed countries wll I result In larger Increases
in oil demand than In developed countries. For more on this
subject, see the EMF-6 report or Griffin and Teece (1982>.
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forecasts were moderately sensitive to the lower growth
9 ass1.111ptl on.
3. 011 Supply Prtce El~sttclty
Balder (1961) cont~tns ~ summ~ry of the OECD otl supply price
elasttctttes contained In the models that were a part of the EMF-6
study. That summary Is reproduced tn Table 3.7. Elasticities
ranged from -0.241 to 1 .162. Balder concludes that the differences
In the ass1.111ed supply price elasticities had a significant Impact
on the EMF-6 forecasts.
In Grtffln and Teece (1962>, which generally contains lower
prtce projecttons than the EMF-6 study, the authors conclude that
"<t>he prtnctpal differences between the vtews presented here and
the Stanford's Energy Model tng Forum appear to stem from
assumptlons about OPEC's behavtor and the non-OPEC supply response.
· ••• The dffferences are not principally due to the prtce elasttclty
of demand assunptlons ••• " <page 214). In addition to bel !ev!ng
that the supply poss!bl I !ties In the non-OPEC countries are greater
than the EMF-6 models assume, the papers In Griffin and Teece argue
that the assumed OPEC production capacity of 34 m!l I ton barrels per
day Is "exces!vely conservative." "(l)f OPEC production reached
38.3 (million barrels per day) In the year 2000. reserves to
9 Balder (1981) contains an analysts of why the different models
In the EMF-6 project produced different price forecasts given the
same Input assumptions. Seider concludes that alternative
assunptlons about non-OPEC supply price responsiveness greatly
Influence the divergence In price forecasts. Balder also concludes
that "(t)he Inclusion of a feedback effect, In which higher of I
prices reduce the economic growth of the of I Importing nations. Is
significant In moderating the magnitude of price changes" <page 3).
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[~ Table 3._7. \£CO oil ~ly elasticities: DF-6 roodels
Q roitls llB; ].gg) 1995 ~ ani 2)10 1!)15 1!)3) Average
[ IEES,.a.tS (1) 0.026 o.3n 0.455 0.283
(2) 0.033 0.319 0.197 0.183
(3) 0.(!;6 0.266 0.425 0.249
[ IPE (1) 0.0 0.0 0.157 O.CBJ 0.060
(2) O.OZ3 0.046 0.119 o.~ 0.()32
(3) 0.017 0.1()) 0.042 0.1ai 0.068
[ Salant/ICF (1) -3.591 ~.~ 0.115 0.509 -2.814 4.7Z3 2.049 2.225 0.3>2
(2) -1.540 -!.all ~.621 ~.863 0.284 0.718 0.552 0.742 ~.241
0 ETA~ (1) 0.713 0.439 0.271 0.569 1.911 0.954 2.628 1.745 1.154
(2) 0.0 1.114 1.521 0.317 co s.n 1.129 -1.251 1.162
(3) 0.0 0.232 0.561 0.876 0.746 0.001 o.n9 0.788 0.5~ r WJIL* {l) 0.007 0.035 0.157 0.318 0.529 1.107 4.402 -2.~ 0.457 u
(2) 0.009 0.027 0.200 0.166 0.392 0.468 0.604 0.371 o.m
[' Kerlle<:tf I (1) 0.009 1.n 0.542 0.841 -1.053 co co co O.S<li
Nehring (2) ~.191 ~.194 ~.193 ~.099 o.cm 0.318 0.~ 0.245 0.029
[ OILT.e.N< (1) O.<li2 1.568 0.858 0.358 ~.005 ~.270 ~.484 ~.4(!; 0.199
(2) 0.037 o.m O.SfB 0.103 ~.101 ~.253 ~.257 ~.175 0.042
(3) 0.114 1.101 0.599 0.047 ~.:m ~.483 ~.491 ~.JJ7 0.035 c Opeconanics (1) 0.0 0.0 0.0 0.0 0.0
(2) 0.0 0.0 0.0 0.0 0.0
U ortJ.M* (1) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
(2) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
c Notes: ( 1) = Reference Ri Oil DSII!M Red.lction s:enari OS
(2) = Reference R1 Lew Elastici~ scenarios c (3) =Reference Ri Higt Price scenarios
* =u.s. elasticities
co = coostant prices ll.rt: a rmzero SLWlY dffferen:e between scenarios;
f these cases are rot i rw: 1 u<Ed in tile averages
u SaJrce: Bei<Er (1~1, page 28)
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produ~tlon ratios In the Cartel Core would not be appreciably
different than In 1980" (page 215>. In the EMF-6 study It was
shown that the stmulatlon.models structured around an OPEC capacity
uti I lzatlon rule gave significantly lower price forecasts when the
capac! ty I eve I was I ncr eased from 3 4 to 40 m I I I I on barrels per day.
See Fl gure 3 .1.
4. Interest Rates
The assumed Interest rate or discount rate can--as discussed
In Chapter 2 --have a significant Impact on the optimal prtce
level set by a proftt maxlmtzfng producer of a'depletable resource.
In a paper by Marshal Ia and Nesbttt <1984> the sensitivity of
changing the discount rate on tne opttmal price path of a profit
maxtmlztng o!l _cartel Is assessed. In the case of this parttcular
study, a change tn the assumed real discount rate altered the
optimal price path less In more distant time periods than fn the
;
near term. Under the assumption that the cartel ts composed of alI
OPEC countries, a decrease In the discount rate from 6% to 2%
Increases the optimal cartel price from $26.33 to $36.25 per barrel
In 1987, from $32.42 to $40.37 per barrel In 1997, and from $49.36
to $50.63 per barrel In 2022.
5. The Backstop Price
The EMF-6 study contained one scenario In which a perfect
substitute for crude oil becomes available In the year 1996 at a
cost of $48 per barrel In 1981 dol Iars --see scenario 8 In Figure
3.1. As can be seen tram F!gure 3.1, this particular technological
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4
breakthrough dfd not result In sharply different price reductions
from either the stmulatton or optlmlzatlon models.
IV. Surveys of Ofl Prtce Forecasts
Recently an
Workshop ClEW>
date, long-term
Informal group known as the lnternattonal Energy
was formed to collect and compare the most up-to-
forecasts of world oll market trends. The group
sends out perlodlc surveys to numerous contributors who provide
stattstlcs on crude-or I prices, GNP growth, prfmary energy
consumption and production, and electrlcfty generation. The
respondents do not provide Information about their model lng
approach, the basic underlying assumpttons of their forecasts, and
so forth. The surveys do, however, obtain responses from all
sectors that forecast market condttlons --e.g., government
agencies, private firms, academia, Individual energy consultants,
and world organizations. Numerous countries are represented.
Typically, the contributors provide only a base case scenario;
however, In some cases contributors wll I provide, for example,
high, medium, and low cases. Projections are given for the years
1990. 2000. and 2010.
In this section the results of two recent lEW surveys are
reviewed. The results of the 1983 survey are given In a paper by
Manne and Schrattenholzer (1984). The results of a more recent lEW
pol I completed In July 1984 were given In a presentation by Alan
Manne at the November 1984. meetings of the International
Association of Energy Economists. Table 3.8 contains summaries of
those surveys.
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In the lEW surveys alI price proJections are given In terms of
Index nunbers where 1980 equals to 100. Note that In Table 3.8 the
lEW results have been converted to constant 1980 dol Iars per barrel
for Saudi Arabian I lght crude. The CIA (1984> reports that the
average prfce for Saudi Arabian I lght crude In 1980 was $28.67 per
barrel.
As can be seen from the table, the median and mean forecasts
have been revised downward from 1983 to 1984 by about $3 to $4 per
barrel for alI forecast years. According to the latest JEW survey,
the median forecasts for 1990, 2000, and 2010 are $27.81, $36.73,
and $46.66. respectively, fn real 1980-dol Iars. The range of
forecasts continues to be high, with-some forecasters predicting
drastic real price reductions and some predicting drastic price
rises.
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Table 3.8. Results of the 1983 and 1984 IEW surveys
NUf.eER MEDIAN ME~ STANDARD RANGE
OF RESPONSE RESPONSE DEVIATION
RESPONSES
FORECAST YEAR
1983 SURVEY
1990 68 $31.54 $31.90 $7.94 $63.93-$20.34
2000 61 $42.43 $41.28 $10.55 $68.80-$17.77
2010 24 $50.17 $49.63 $14.74 $76.26-$14.34
FORECAST YEAR
1984 SURVEY
t 990 57 $27.81 $29.11 $7.69 $63.93-$20.07
2000 54 $36.7 3 $37.69 $9.92 $62.50-St 8.64
2010 16 $46.66 $47.54 $15.74 $76.26-$15.77
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4 4. CONQUS IONS
"Energy forecasting Is a hazardous occupatfon.
projection Js doomed to be Incorrect"
Schrattenhofzer, 1984, page 48).
Introduction
V f rtua I ly arry
(Manne and
The purposes of this paper have thus far been to (1) review the
different model lng approaches that have been developed to explain
historical oJI price changes and forecast future price trends, and
<2> review, Interpret, and criticize price forecasts that have
resulted from these methodologies. In this concluding chapter we
review the conclusions that can be drawn from Chapters 1, 2, and 3
In regard to these general purposes and address the degree to which
there exists a consensus on model lng approaches and price
forecasts. In addition, this chapter presents a subjective
assessment of future all market trends based on the conclusions
drawn from previous chapters. Of particular Interest fs· how market
structural changes --resulting from both economic and pol !tical
pressures--mav Impact future all prices. Finally--and again
drawing on conclusions from previous chapters --this chapter
contains thfs author's subjective judgment of all price trends for
the 1987 to 2022 tfme period. In addition to providing high,
medfum~ and low price trajectories for "business-as-usual" market
conditions--conditions In which the basic structure of the world
all market remains relatively unchanged--the lmpl !cations of a
severe oil supply disruption and a ruther breakdown of OPEC's
cohesion on oil prices are also considered.
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I 1. A Summary of Conclusions from Previous Chapters
A revtew of the conclusions from the previous chapters Is In
some WtlfS dtfftcult., because one of the main thrusts of those
chapters Is that after more than a decade of Intensive study of the
world oil market there Is I lttle consensus about the way prices are
formed--which Is., of course, In Itself a major conclusion.
However., In a more positive vein there are several general
conclusions that can be drawn from a review of the hlstory of the
oil market., the models to represent that market., and the forecasts
from those models.
The overrldtng concluston Is that ln alI three are~s --I.e • .,
the market., the models, and the forecasts --there has been
slgnlflcant evolutlon within the past decade. A review of the
structural changes In the oil market slnce the late 1960s shows
drastlc and contlnual changes tn the relevant players that have
slgnlflcant control over the pricing mechanism, the relevant
objectives of those players, and the abl I !ties of those players to
manipulate the market to real lze those objectives. During the
1970s the major producing countries gained significant control over
production decisions within their own countries and thus gained
sIgnIfIcant control over oil prIces. In the ear I y_ 1 980s that
control began to decl lne as non-OPEC producers Increased production
and maJor consuming countries reduced consumption In response to
the drastic price escalations of the 1970s. In addition, the
objectives of the players--particularly, but not exclusively, the
major producers --rr.ety have changed over time as pol !tical
objectives outwel~hea wealth maxlmlz!ng goals and as demands for
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oil revenues became tncreas!ngly Important to ambitious development
progrsns. Pol Jtlcal decisions within some consuming countries also
led to structu~al changes--for example, the removal of oil price
controls In the United States.
There has been an equally Impressive evolution In the ways the
market has been modeled. During the early 1970s models largely
followed dlsclpl lnary lines, with variations within each dlsclpl tne
to account for different perceptions of the structure of the oil
market. To a great extent these models were built by economists
who typically used very rigid orthoqox theoretical approaches to
represent a market that was, In fact, undergoing great structural
change. Very elaborate mathematical models arose to represent how
a monopol Istre producer would produce or set prices to maximize
discounted profits. However, the sophistication was based largely
on tne theoretical and empirical refinement of a rather slmpl tstlc
underlying objective function--wealth maxlmlzatton. Economists
In large part Ignored the fact that major oll producing countries
are not subject to the same kind of forces that a competitive or
even monopol lstlc producer faces wlthln a capital lstlc market
environment--I.e., the threat of takeover when profits are not
maximized. From this real lzatlon arose what may be termed
"sufficing" models that adopted alternative objectives, such as
meeting a minimal revenue requirement.
The decision to employ producer objectives other than wealth
maximization resulted In models that more closely resembled the
real-world ell market; however, It also opened a whole new set of
Issues. If profit maximization Is not necessarily an objective
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that the major producers wll I follow, or wJI I eventually be forced
to follow because of market pressure, what objective should be
used? It Is ot this point that many modelers real lzed that
pol ltlcal objectives plav a major role In the production and
prJcJng decisions of many producers and should be expl lc!tly or
Implicitly Inc I uded In any model of the world oil market. The wavs
pol !tical considerations were Included differed. In sane models
pol !tical constraints were Imposed on an otherwise economic wealth
maximizing approach. In other models the pol ltlcal process was
tantamount to or exceeded alI economic market forces. Some
modelers opted for Informal models that Jmpl lcltly contained
economic and pol ltlcal considerations.
Therefore the major conclusions to be drawn from more than a
decade. of model Jng the world oJI market Is that the oJI market Js
continually evolving and world oJI models must continually evolve
to more closely represent that market. One can also conclude that
the general thrust of future models wll I be to employ an
lnterdlsclpl Jnary model lng approach to address the complex
economic-pol !tical questions or to use a slmpl Istlc rule of thumb
In forecasting prices, such as setting prices as a function of an
exogenously specified OPEC capacity utJI lzation level.
In addition, there Is an Increasing real lzatlon that any
forecast of world ell prices Is highly uncertain. The general
trend Is to deemphasize specific point projections and concentrate
more on the probable range of future prices. Although recent
forecasts of oil prices for the next 30 years are generally down by·
$3 to $5, reflecting the recent official OPEC price reduction, the
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vartatton tn the forecasts rematns high. The medtan response of
recent forecasts Is that Jn real terms oil prices wll I remain flat
until about 1990. Be~een 1990 and 2010 the median forecast Is
that real prices wll I Increase by between 2 and 3 percent yearly.
J
I I I. A Subjective Assessment of Future Market Trends
Given the various caveats discussed In the above section, this
sectton dtscusses the current oil market environment and presents
thts author's own subjective assessment of future market
cond I tl ons. At the time of this wrlttng the oil market continues
to be "soft" and many Industry offtctals predtct further price
cuts. In an effort to support Its $29.00 base price, OPEC recently
agreed to cut Its production ceiling from 17.5 to 16 mtl I ton
barrels per day, with the major producing countries accepting the
majority of the cuts. However, otl compantes continue to put
pressure on OPEC and non-OPEC producers to make prtce concessions
as of.ftctal prices continue to exceed prices on the spot market.
For example, pressures on producers of North Sea oil --!.e.,
Norway and the United Kingdom--place Indirect pressure on Nigeria
which produces crude of a stmllar type. Nigeria's wei I publ lcfzed
revenue needs make price concessions more probable In the event of
a North Sea prtce reduction and thus continues to threaten the
prtctng structure of OPEC.
However, one must be careful .to distinguish between short-term
market signals and probable long-term market posslbll ftles. In the
long term three widely divergent price paths are possible. First,
the all producl ng countr f es may "weather the current storm" and
maintain their pricing cohesion, It not their current $29.00 base
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price. The strength of OPEC Ts largely dependent on the abl llty of
Saudi Arabia to absorb the necessary production cuts to maintain
their desired price. Second, demands for revenues In the major
producing countries mav force production levels that are
Incompatible with current prices, or the major producers may be
forced to "pol Ice" members of OPEC and non-OPEC producers by
allowing prices to fal I, at least temporarily. A significant price
reduction of this type could alter the world price trajectory for a
period of decades. Third, pol ltcal turmoil In the Persian Gulf
area that results Tn the long-term disruption of crude from Saudi
Arabia and other large Persian Gulf producers could cause drastic
escalations In price, such as those observed In the 1970s. Most
oil analysts agree that such a disruption, even during soft-market
conditions, would result In severe price Increases.
The most probable of these three broad scenarios Is the first
I.e., the present basic structure of the market wll I remain
Intact. It Is generally felt t'hat the benefits to be received by
oil producers from maintaining the current structure are large
enough to prevent OPEC and non-OPEC producers from entering a
"price war" that could significantly reverse the price escalations
of the 1970s. Over the longer term, It Is general Jy agreed that
OPEC wll I Increase Its share of the ol I market as non-OPEC reserves
dwindle and world economic growth--especially In the developing
countries causes significant Increases In world ol I consumption.
Financial reserves within the major producing countries, such as
Saudi Arabia, should be sufficient to allow production reductions
that will prevent an "all-out pr!ce war."
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~Is does not mean, however, that the probabll ltles of the
other two extreme scenarios are Infinitesimally smal I. In another
paper by this author <Curlee, 1984), It Is argued that the current
pressures being exerted on the structure of the world oil market
Increase the probabilities of both further, and possibly severe,
oil price reductions and severe price Increases, as compared to
the more stable market conditions of recent years. On the one
hand, revenue pressures In the more ·populous producing countries
may lead to pol ltlcal unrest that may result In the current
governments of those countries being replaced. An example of these
pol ltlcal pressures Is the recent coup In Nigeria. In order to
Increase revenues, some countries within OPEC may elect to Increase
production with or without the approval of OPEC. There Is evidence
that this Is happening currently. If this occurs, more pressure
wll I be placed on the major producing countries to reduce their
levels of production. There are, however, I lmlts below which even
the major producing countries cannot be expected to reduce
production. Chase Manhattan Bank (1984) projects that OPEC's
current-account deficit will Increase to $16 billion In 1985 fran a
level of $15 bl II ton In 1984. Although the major core members of
OPEC--I.e., Saudi Arabia, Kuwait, United Arab Emirates, and Qatar
--have about $300 bl II ton In foreign assets, It Is clear that they
could not be drawn down significantly without some degree of
Internal turmoil. In the event that the core OPEC members no
longer pol Ice their production I lmlts, severe price reductions are
possible. These dow~ward pressures on price would be further
Increased If Iran and Iraq end their war and resume production at
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pre-war rates. OPEC as a whole has the ab!l Jty to Increase
production by about 8 mrl I Jon barrels per day over their June 1984
10 levels, given their current available production capacity.
On the other hand, the Internal pol !tical pressures resulting
from unmet revenue needs could result In violent confl let within·
and among the producing countries. Any v!olent confrontation
Involving the maJor producers of the 'Persian Gulf area would
probably result In severe price Increases. In the event of the
loss of all Persian Gulf product!on capacity, total OPEC capacity
would be reduced from 34.840 to 11.725 mil lion barrels per day.
Production losses would be about 11.630 mil lion barrels, based on
June 1984 production levels. Given that with the loss of the
Persian Gulf producers, OPEC excess-production capacity Is only
about 3.220 m!l I Jon barrels per day and I Jttle excess capacity
exists In non-OPEC countries with the possible exceptions of
Mexico and Canada--significant panic and price Increases could be
expected In the world oil market. The exact price Increases that
would result are virtually Impossible to predict. ThIs type of
disturbance represents a worst case scenario.
Of course, con~luding that the most I lkely scenario .Is one In
which there Is no drasttc change In market structure only
marginally reduces the problem of forecasting prices. Within this
broad scenario there are numerous unknowns that may greatly Impact
oll prices. However, drawing upon the opinions of numerous
Industry experts, sane general cone I us! ons can be drawn. Fl rst,
10 The CIA (1984) reports that as of September 1984 total
available OPEC produc-tion capacity was 26.175 million barrels per
day. Production In June 1984 was 18.215 million barrels per day.
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there·ls significant evidence that neither non-OPEC suppl lers nor
major consuming countries have fully adjusted to the drastic price
Increases of the 1970s. · This continued adjustment wll I tend to
dampen the demand for OPEC oil, at least throughout the remainder
of the 1980s. Second, estimates of economic growth are relatively
low which suggests that major off demand Increases wfl I not result
from Increased economic activity. However, even If growth exceeds
the current projections. recent work by Daly. Griffin, and Steele
(1982> suggests a long-run ofl demand elasticity of only about 0.75
with respect to economic actfvtty. A key unknown, however, Is how
econom rc growth In devel opt ng countrt"es w II I trans I ate Into
Increases In oil consumption. Third, the level of OPEC production
capacity does not appear to be a binding constraint In either the
mid or long term. Huge levels of excess capacity currently exist
and there appear to be few reasons that OPEC could not, or would
not, Increase production capacity should the need arise In the long
term. Fourth, various experts suggest that It Is not In the
Interest of OPEC to desire large price Increase because of the
I lkely responses of non-OPEC suppl lers and oil consumers to those
Increases. Because of these reasons It Is most I lkely that real
oil prices wll I remain constant throughout the remainder of the
current decade.
However, due to resource depletion In non-OPEC countries and In
some OPEC countries, real price Increases are Inevitable
eventually. Further, once the world or I market becomes "tighter"
In the late 1980s and early 1990s, there Is an Increasing
probabl I tty of short-term price spikes resulting from temporary
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suppl4y dt sruptt ons. There rs a growtng consensus. however. that
prtce sptkes resulttng from temporary supply dl sruptfons wl II not
result In drast!cally different long-run price trends because those
hfgher prtces are not In the Interest of the major producers.
Taktng the opinions of the various experts tnto account. real prtce
Increases of about 2 percent per year appear to be most probable.
IV. Future 011 Prtces
Figure 4.1 gtves oJI prtce forecasts for the t[me pertod 1987
to 2022 In ftve ye~r tntervals under the assumption that there are
no stgnlftcant market disturbances. The base case forecast t s
computed under the assumptton that real otl prtces rematn constant
tn 1984 dol Jars throughout the rematnder of the decade. Prtces for
the remaInder of the · forecast pert od are assumed to t ncr ease by 2
percent per year tn real terms. The htgh and low projections are.
admtttedly. reached tn an ad hoc way. If selecting a most I tkely
base case from the numerous forecasts dtscussed tn Chapter 3 ts
rtsky. selecttng a probable range around that base ts dangerous.
In order to share that danger --or at mlntmum have some stated
reason for selecttng a range--the standard devlattons of the
forecasts from the most recent lnternattonal Energy Workshop were
used. The htgh projections for the years 1987 and 1992 were
obtained by addtng one standard deviation from the 1990 lEW
forecasts to the base case results. The low projecttons were
obtatned by subtracting one standard deviation from the base case.
The high and low projections for the years 1997 and 2002 were
obtained by adding and subtracting one standard deviation from the
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Table 4.1. Oil price projections
1987 to 2022
(In constant 1984 dollars per barrel) c Year Base Low High
[ 1987 $29.00 $21.00 $37.00
[ 1992 $30.00 $22.00 $38.00
1997 $33.00 $23.00 $43.00
c 2002 $37.00 $27.00 $47.00
2007 $41.00 $25.00 $56.00
r~
L 2012 $45.00 $29.00 $61.00
[ 2017 $49.00 $34.00 $65.00
2022 $55.00 $39.00 $70.00
[ Note: Rounded to the nearest dollar
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forecasts for the year 2000. AI I remaining high and low
projections were obtained using the standard deviation from the lEW
projections for_the year ·2010.
It Is all but Impossible to project how prices might change
under the two extreme scenarios discussed Jn the above section. In
the case of a "price war" Jn which OPEC countries Increase
production sharply In an attempt to Increase revenues, world prices
could drop sharply--Into the $15 to $20 prfce range. Possibly
the more Important question for consumers and producers wfthfn the
Unfted States fs, however, the degree to whlc~ the U.S. government
would allow prfces to drop. It fs most probable that a tarfff or
quota would be set so that U.S. Investments In off production and
use technologies that depend on relatively high off prices would
not become Jnsfantly outdated. The tarfff or quota would be done
In the name of --and could be argued for on the basts of
reducing future U.S. vulnerablltly to events In the world off
market. Real domestic prices below the $21 per barrel level might
face significant opposition. In 1984 dol Iars the world price of
oil was about $21.75 before the price escalation following the
Iranian Revolution.
Likewise Jt Is very difficult to predict how the market would
react to a large and prolonged disruption of Persian Gulf ofl. In
the EMF-6 report the models used In that study were exercised under
the assumption that a permanent but unanticipated reduction In OPEC
capacity of 10 million barrels per day would be Initiated In 1985
while the world ot I market Is projected to be "soft." Figure 4.1
shows how the varrous models responded to the scenario. For each
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···••·•••·••••••••·•••· ETA·MACRO
(\
---Gately
--------IEES·OMS
f. \ · · · · · · · · · · · · Kennedv·Nehring
.• \ ----OILMAR
: •·.••• , OILTANK
•. •· •••••. ,... ..... ·-·-·-~ -·-·-·-·-·• WOIL
7····.. '~-.... / . ··.. ' ..... /·
! ······... "·......... / I ··... ,~·, . ··.. . .... ;(. I .. • . ··... . ....
. '• I I ·····... ..._/ ...... } : ···i; ·· .. .A.. .....
/ ,' ; " -.. / : ,' i I "",, /
.:' . .......... / :,' r ~~--...-·~ -----j· I i ,;' -............ ./.:.-'· ................. . 1/ ................. ... ,: ;:: / ...... ·: ,"" , -........ _
120
80
,. /
40 ---,.,,., ............... __ .,..,.,.
1982 1984 1986 19!!8 !990 1992
Fig. 4.1. EMF-6 price projections given a permanent
10 million barrel per day capacity reduction.
Source: EMF-6 (1982, page 58)
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..
one million barrel per day reduction in capacity, the models --
with the exception of one--projected that prices would increase
by between SS and $12 dollars per barrel. As can be seen from the
figure, the impacts of the disruption
significantly from model to model.
scenario represents a worse case with
occurrence.
V. Final Conclusions
over the 1 eng term vary
Once again, this extreme
a small probability of
The dominant conclusions from this paper concern not what we
know about the functioning of the world oil market, but rather what
we do not know and how what we do not know can influence our
perceptions of future market trends. In some senses, we as
students of oil markets have asked as many questions as we have
answered about how oil prices are formed. Further, there is an
increasing recognition that the answers to the questions, as well
as the relevant questions, are constantly changing as oil analysts
track a constantly moving target. Methodologies developed to study
past market changes and suggest future market directions have
evolved as modelers identify and begin to study the extremely
complicated set of parameters that determine oil prices. But
foremost, oil forecasters increasingly recognize the vulnerability
of their trade to conceptual and empirical uncertainties. Users of
forecasts are increasingly warned that projections reflect specific
assumptions about the structure of the oil market and the key·
market parameters that are dictated by the use of a particular
methodology. If history has not necessarily made forecasters of
oil prices more accurate, it has made them wiser.
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4
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