To understand the future of oil, ask the right question

“WHY CAN’T WE predict the price of oil? That’s the wrong question. What we should ask is, in a non-linear world, why would we think oil prices can be predicted. Practically since the dawn of the oil industry in the nineteenth century, experts have been forecasting the price of oil. They’ve been wrong ever since. And yet this dismal record hasn’t caused us to give up on the enterprise of forecasting oil prices.

Vast numbers of intelligent people continue to spend their days analysing data and crafting forecasts that are no more likely to be right than all those that came before. Nassim Taleb, author of The Black Swan, recalled giving a lecture to employees of the U.S. government about the futility of forecasting. Afterward, he was approached by someone who worked for an agency doomed, like Sisyphus, to do the impossible. ‘In January, 2004, his department was forecasting the price of oil for 25 years later at $27 a barrel, slightly higher than what it was at the time. Six months later, around June 2004, after oil doubled in price, they had to revise their estimate to $54,’ Taleb wrote. ‘It did not dawn on them that it was ludicrous to forecast a second time given that their forecast was off so early and so markedly, that this business of forecasting had to be somehow questioned. And they were looking 25 years ahead!’ That 25-year prediction was actually modest. The international Energy Agency routinely issues 30-year forecasts.

In 2005, as oil prices climbed steadily and sharply, Steve Forbes, publisher of Forbes magazine, said it was a bubble that would soon pop. ‘I’ll make a bold prediction,’ he said. ‘In 12 months, you’re going to see oil down to $35 to $40 a barrel.’ The price kept rising. By 2007, a new consensus had emerged: oil was going higher. And it did. In the first half of 2008, oil pushed above the previously unimagined level of $140 a barrel. ‘The Age of Oil is at an end,’ declared environmental writer Timothy Egan in the New York Times, echoing, whether he knew it or not, M.King Hubbert’s declaration thirty-five years earlier. Experts who had led in forecasting the rising trend became media stars, quoted everywhere, and what they had to say was not good: The price would continue to climb. It will break the $200 mark soon, predicted Arjun Murti at Goldman Sachs. Jeff Rubin, the chief economist at CIBC World Markets, agreed. ‘It’s going to go higher. It might go way higher,’ investment banker and energy analyst Matthew Simmons said on CNBC. ‘It’s not going to collapse.’ Simmons said that in July 2008, when oil was selling at $147 a barrel.

It didn’t go higher. In September 2008, financial markets melted down, precipitating a dramatic slowing in the global economy. The experts hadn’t foreseen that. The decline in growth drove down demand for oil. By December, oil traded at $33 a barrel. If any analyst had made that call six months earlier, when the price was more than four times higher, he would have found himself out of a job.

Maybe the era of Mad Max really is coming, finally. Or maybe cheap oil will rise from the dead once again. Or maybe new technologies will surprise us all and create a future quite unlike anything we imagine. The simple truth is no one really knows, and no one will know until the future becomes present. The only thing we can say with confidence is that when that time comes, there will be experts who are sure they know what the future holds and people who will pay far too much attention to them.

Reprinted with permission.