The Perils of Prediction

In the television show Cheers, Frasier Crane was always trying to bring a little culture to the patrons of the bar. It made for some of the more comedic moments in the program. Once, Frasier read the introductory sentences to the Dickens classic A Tale of Two Cities to the aloud to his friends.

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only."

After hearing this into, Cliff Clavin said "That Dickens guy really knew how to cover his butt."

And so it goes with predictions! In January, when crude was hovering around $100/bbl, the NY Times released an article on the difficulties that economists and traders have placing fair value on the price of crude. There were several comments in this article that struck me.

“Predicting oil prices continually demonstrates the perils of prophecy, because oil prices are the derivative of what happens in the global economy and global geopolitics,” said Daniel Yergin, chairman of Cambridge Energy Research Associates. Mr. Yergin said he could foresee oil prices surging as high as $150 in the next few years or falling as low as $40.

John Richels, president of the Devon Energy Corporation, an international oil and gas company based in Oklahoma City, said $150 a barrel was possible, but so was $55. “We have to make investments based on our outlook over a long period of time,” he said. “It is tough.”

The reason I remembered these comments is that the ranges were very wide, and that both analysts took the current price as the midpoint of their range. I began to ask folks that I worked with and folks that I talked to what kind of range of prices they expected for the upcoming year. Very few had a $100 dollar range from low to high, but almost all of them placed the then-current price in the middle of their low-to-high range. Interesting huh?

I guess the reason I choose to write a post on that article 10 months later is that here we are...having hit very close to $150 in the seven months since the original publication. And...with a very good chance to hit $50 oil in the next year, at least based upon the commentary of Nouriel Roubini.

Yergin and Richels both hedged themselves by estimating a wide range of prices. I bet neither of them ever thought that we might run through BOTH the top and bottom of their estimates in a twelve or eighteen month period.

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