Forecasting Oil Prices

Let’s use oil markets to say welcome to two new blogs from very different Republicans. Alas, the first is from Lawrence Kudlow who removed one of his posts but NRO still has this version:

$55 Oil Won’t Last…Ultimately, the answer to high oil prices is a lot more production. That’s exactly what the Bush administration intends to do.

It seems Lawrence was shilling for Bush’s ANWR policy. Two pieces of good news. John Kerry was firing up his base to garner support in opposition to the ANWR legislation. And the other piece of goods news is that we can know enjoy the blog from Calculated Risk (OK, CR has already introduced himself as our new and very able colleague). While Kudlow focuses on U.S. production, CR focuses on the world market for oil and has a nice time series of production and consumption of oil by China.

Alas as Mr. Kudlow (who once said the Iraq War would lower oil prices to $12 per barrel) had predicted it would not go above $55, other bloggers including Kash and David Altig were giving more sober readings of the current oil market.

My contribution to this discussion draws from the Energy Information Agency and its Annual Energy Outlook 2005 with Projections to 2025. Their model forecasts the positions of the U.S. demand and supply curves for the period from 2005 to 2025 and essentially treats the U.S. as a price-taker. Since the Energy Information Agency realizes it is hard to predict what OPEC will do as suppliers and what world demand will look like in 2025, they provide different forecasts using world prices as low as $21 a barrel to as high as $48 a barrel (all in 2003$). The following chart shows that if prices stay high, we are projected to consume 3.6 times as much as we produce. Now, maybe prices will plummet as Kudlow suggests but the effect of lower prices is to reduce U.S. production and to increase our consumption so we will consume 4.3 times as much as we produce with higher imports making up the difference.

These forecasts do not say reducing our excess demand for oil is not a good idea. Anything that would increase domestic production or reduce our consumption would tend to reduce our imports – and might even have some impact on reducing world prices. But proponents of the ANWR legislation exaggerate the benefits of it and understand its costs. Besides – when one’s economic modeling approach begins with what would Karl have me say, it is likely not to be a very reliable means for forecasting.