Forecasting the prices of commodities such as natural gas and crude oil is far from a scientific endeavor. It is pure art, which means a lot of estimating and approximation – closer to crystal ball gazing! Sure, statistics, computer modeling, mathematics, and a host of more scientific ways and means play a role in the eventual outlook, but it is still art. A ouija board would be an ideal instrument in the forecasting business.
Reason for the difficulty is that estimating the future prices of primary energy products like crude oil and natural gas includes a multitude of variables. Even products like gasoline and distillate have more variables. Many of these variables, while somewhat predictable, are more the products of Mother Nature, chance, or economic forces beyond human control or even conception.
Who can predict with certainty what the weather will be six months from now when it is difficult getting next week’s forecast? Economic changes can change with political winds. Government impact is an unknown, especially with changes in the administration and pressure from environmental and climate-concerned groups. Forecasting – it is art, not science!
Crude oil and natural gas, in the big picture, ultimately follow the outcome of the supply/demand scenario. Crude oil, which is more an international commodity and so much the basic fuel of the transportation industry, is more complicated to predict although it has many factors in common with natural gas. Because of space limitations, this article will look only at the forecast for natural gas and some of the factors that influence the expected prices. Still, to set the total picture, a crude price forecast is also made.
Crude oil markets have returned from the highs and lows of 2008 (monthly average $134/B and $41.43/B, respectively with a high of $147.27/B in July 08) to levels about half of the highs reached then. West Texas Intermediate (WTI) prices are running about $70-75/B.
Average price in 2009 was $62/B, according to the government’s Energy Information Administration (EIA). Expectations from the EIA are crude will average $80/B in 2010 and $84/B in 2011.
Natural gas prices were more volatile than crude oil (no pun intended) since their highs and lows of 2008 were for a monthly average of $12.69/MMBtu and $5.83, respectively. The high reached in July 2008 was $13.75/MMBtu at Henry Hub. In the past 18 months, Henry Hub gas prices have gone from a monthly low of $2.94/MMBtu reached after the 2008 high to a monthly high of $5.18/MMBtu in January 2010. Current Henry Hub prices are around $5.50-5.75/MMBtu.
The estimate by JOFREE Energy Consultants for 2010 is $5.90/MMBtu and for 2011, $6.60. Since forecasting is an art, not a science, and since perception is an individual thing, some additional forecasts offer an interesting analysis of what to expect. The natural gas price is $5.37/MMBtu for 2010 and $5.86 for 2011 as forecast in the EIA February 2010 Short-Term Energy Outlook.
Another good source of gas price forecasts is the quarterly forecast made by the trade publication, Natural Gas Week. With about 18 respondents comprising the forecasting panel, its projected prices when converted to Henry Hub prices are $5.61/MMBtu for 2010 and $6.16 for 2011.
Interestingly, its forecast range is from $6.50 to $4.60/MMBtu for the sample for 2010, giving a standard deviation of about 13%. Another media source of gas price forecasts is Reuters. Its 2010 average of 26 respondents for Henry Hub pricing is $5.87/MMBtu with a range from $9 to $3.60, giving a much higher standard deviation of around 70%. Its 2011 forecast is $6.40/MMBtu. Easy to see why forecasting is an art!
Those making these forecasts fall into several categories. Financial-oriented companies including banks, traders and marketers are one group releasing price forecasts. Another group is consulting and market research organizations, both domestic and international. Last is the government.
The forecasters use everything from sophisticated econometric models to plain estimating and analysis methods. Most of the forecasts are tied to the Henry Hub prices for natural gas since this is the location of the futures market for the New York Mercantile Exchange. Some forecasts are tied to field prices for gas in the predominating gas production areas of the Southwest.
What goes into the basic models and calculations for the price outlook are the various factors comprising the supply-and-demand balances. This includes historical data as well as projections from various sources on future supply and demand.
While the historical is fairly rigid and the EIA provides one of the best sources for data, it is with the future of both supply and demand, that fact and perception get mixed and results can vary significantly. Uncertainty of everything from weather, sources of supply, economics, government policy and environmental impact make forecasting difficult.
To highlight some of the distractions to this year’s forecast just in the supply side, look at natural gas production statistics and potential factors. The EIA expects 2010 U.S. natural gas production to decline 2.6% to 58.7Bcfd/d with a slight boost in 2011. The drop is based on the decline in drilling rigs during 2009 and the modest uptake since then. Imports from pipeline sources are expected to be slightly lower again this year but increased imports of LNG should moderate this decline.
In any case, there is plenty of supply to meet demand projections. Demand is impacted mostly by weather and economics. Contrary to the climate warming mentality, 2010 is expected to be a colder year and hopefully, the economy will continue to improve. These two unknowns contribute greatly to the uncertainty.
Also playing a role in 2010 forecasts and farther out is the potential of government and environmental concerns. Natural gas is the cleanest-burning fossil fuel both in the combustion products released and in developing supplies from the ground. It is a domestic-based fuel with about 12% coming from imports. Yet many governmental and environmental advocates are against further natural gas development and increased usage in the U.S. Cap-and-trade laws, restrictions on drilling offshore locations and other possible gas production areas, restrictions on shale gas development because of fears from fracturing could have a significant impact on gas supply.
All of these factors contribute to the difficulty of price forecasting, leading some to consider it a useless exercise. While the results of any forecast should be taken with a grain of salt in perspective, the forecast is an absolute necessity to business.
Forecasting is a must for proper business planning. While every effort should be made to increase the confidence of the forecasted numbers, it is the best there is! By having many different sources coming from different avenues of the business spectrum for projecting prices, users can develop their own confidence levels. Without timely, state-of-the-art pricing forecasts, chaos would rule and business operations would suffer in energy as well as many other industries.