Oil Price Forecasting: It’s a Mug’s Game

To paraphrase Ralph Waldo Emerson, foolish precision in the face of uncertainty is the hobgoblin of energy forecasters.  Much has been made recently about how energy forecasters—private and government—seriously underestimated the large increase in crude oil prices that has taken place in recent months.

What is surprising is that so many have been surprised and that so many so-called analysts continue to make point estimates. Crude oil prices have never been easy to forecast very far in the future, except under very stable conditions. And, that difficulty in forecasting also applies to oil companies who have a very strong economic incentive for greater accuracy.  The problem is that there is a great deal of uncertainty in the political, economic, and technical factors that can drive price.

In spite of sophisticated models, forecasters too often assume that the near term will be like the present at that influences how they treat economic and political factors.  Most important, point estimates for uncertain variables guarantees that an estimate will only be correct by luck.  How much the dollar will strengthen or weaken, how companies will respond to rising oil prices, whether shale producers will start drilling or maintain fiscal discipline, how much global growth will occur, whether OPEC producers begin to cheat and how much, how much Iranian and Venezuelan production will fall, and the impact of political risk are all factors that work against point estimates.

Bill Gilmer, Director of the Institute for Regional Forecasting, in a recent Forbes article made the obvious point that the world is dynamic; forecasts are static in that they are based on information available at the time they are made.  It is one thing to use available data to look ahead; it is something else to pretend to divine the future with relative precision.  Gilmer points out that “it doesn’t take big headlines to upset the forecast. The global crude oil market depends on the politics of dozens of producing countries, economic cycles in consumer countries and a vast infrastructure of pipes, ships and refineries. Even if we account for the known issues correctly, we could list 1,000 or more low-probability events that could push our forecast off course. … if these events are independent of each other, the chance that at least one will significantly and unexpectedly affect the oil market within a year is 1-(.999)1000 or 63.2%.”

Oil price forecasts would be more credible if they provided ranges reflecting uncertainty.  Otherwise, forecasting is a “Mugs Game,” an exercise in futility.

The Myth of OPEC Power

OPEC’s “production” cuts which in fact are an illusion. Prior to the agreement in 2016 to cut production 2%, most OPEC producers increased their production with Saudi Arabia leading as a way to maintain market share.
As oil prices have risen above $60 a barrel, more attention has been given to
As some have observed, the cuts were really just a pull back from the production surge. Since then according to EIA data, OPEC production has not decreased. In 2016, it produced 39.2 million barrels a day, last year it produced 39.2 million, and that is the forecast level for this year. So, while it appears that OPEC production has remained constant, production has actually been increasing to offset the decline in production by Venezuela. Venezuela’s oil production has been declining for two decades as a result of nationalization. In the past two years, its decline has increased, dropping from from 2.3 million barrels a day in January 2016 to 1.6 million in January of this year.

Since other member countries have increased their production to maintain OPEC’s overall level of production it is easy to see why its production agreement has not been breached. A look at OPEC’s 50-year history shows that for most of that history, it has been a price taker and not a price maker. That history also shows that most of the member countries cheat to gain or maintain revenue. Price volatility is clear evidence that OPEC’s alleged market control has always been an illusion.

There are several reasons why oil prices have been increasing. The $30-$40 dollar levels were below what many believe to be the long term equilibrium level. Over the past year, the inventory glut has been reduced as a result of a strong global economy, especially Chinese demand. Add to that increased political turbulence in the Middle East where the Trump Administration has introduced a higher level of uncertainty. Increased tensions with Russia, North Korea, and the potential re-imposition of sanctions on Iran. All of those factors put upward pressure on crude oil prices.

Oil prices are cyclical. They never stay low and they never stay high. Today’s prices are leading to increased production and based on history will lead some members of the OPEC-Russia production agreement to cheat. The likelihood of a return to $100 a barrel oil is remote unless there is some external event that spooks the market.

Quit Digging

There is an old adage that when you are in a ditch, quit digging.  EPA with the help of corn state representatives dug a ditch when they created the ethanol mandate, the  renewable fuel standard and then created renewable identification numbers-RINs—as a mechanism to track compliance with  blending requirements.

RINs worked to the advantage of companies with blending capabilities but created a big disadvantage for independent refiners that had to buy RINs—blending credits.  In addition, traders found a way, as they always do, to turn RINs into a commodity that they could buy and sell and hence turn a profit.

Recently, the largest independent refiner on the east coast declared bankruptcy because of  the high cost of RINs.  According to the Wall Street Journal, Philadelphia Energy Solutions, has spent over $800 million purchasing RIN credits since 2012. That is more than the pay and benefits for its 692 workers.  Spending money to purchase credits certifying that a company has blended ethanol with its gasoline is shear insanity.  Ethanol has no environmental benefits, it can be corrosive to engine parts, lower gas mileage, it can’t be shipped by pipeline, and it raises food prices.  There is only one reason for the renewable fuel standard, to transfer wealth from motorists to corn growers and ethanol manufacturers.

Having distorted the gasoline market with a requirement that has no benefits, EPA now plans to make the situation worse by either setting a cap on the price of RINs or allowing independent refiners to purchase credits directly from the federal government.  We experienced price controls in the 1970s and they proved to be an economic disaster.  Markets set prices through the interactions of a large number of buyers and sellers.  This process conveys information on supply and demand.  To think that the federal government can duplicate that discovery process to determine the price of RINs is wooden headed folly.  There are only two things that are certain with the approach being considered.  A system that has no value beyond enriching the favored will become ever more complicated and traders will figure out how to game the system to continue making money from it.

EPA has made the ethanol hole bigger over time and should simply stop digging by beginning the process of withdrawing the useless renewable fuel standard.  In the meantime, EPA can simply give away RINs. Refiners report production to DOE, so gallons of gasoline produced would have to match assigned RIN credits.  A similar process could be used for imported gasoline.

The Three Stooges of Trade

Groucho Marx once observed that politicians look for problems, find them everywhere, misdiagnose them, and apply the wrong solutions.  That insight perfectly fits the wrongheaded trade policy developed by Wilbur Ross, Peter Navarro, and President Trump.  On reflection, equating this three to the three stooges does Moe, Larry, and Curly a disservice.   The level of economic ignorance being shown by the President’s action is breathtaking, especially since Peter Navarro was trained in economics.  He must be like. Paul Krugman who has locked his training away is favor of ideology.

Economists disagree about many things but on the subject of tariffs they are virtually unanimous.  They are bad.  In 2002, President George W. Bush imposed steel tariffs and it cost the economy 200,000 jobs and $30 billion.  Navarro-Ross could become the Smoot-Hawley of 2018 if a trade war follows. The EU has already developed a list of US products that will be hit with retaliatory tariffs.

Someone should tell the President that every dollar that goes overseas as a result of the purchase of a foreign good works its way back here through investments or purchases of US products.  The trade relationships that develop in our interconnected world work towards stronger relations among nations which helps preserve peace.

At the time of Smoot-Hawley, over 1000 economists wrote a letter in opposition.  In part it said, “We are convinced that increased protective duties would be a mistake. They would operate, in general, to increase the prices which domestic consumers would have to pay. By raising prices they would encourage concerns with higher costs to undertake production, thus compelling the consumer to subsidize waste and inefficiency in industry. At the same time they would force him to pay higher rates of profit to established firms which enjoyed lower production costs. A higher level of protection, such as is contemplated by both the House and Senate bills, would therefore raise the cost of living and injure the great majority of our citizens.  … We would urge our Government to consider the bitterness which a policy of higher tariffs would inevitably inject into our international relations. The United States was ably represented at the World Economic Conference which was held under the auspices of the League of Nations in 1927. This conference adopted a resolution announcing that “the time has come to put an end to the increase in tariffs and move in the opposite direction.” The higher duties proposed in our pending legislation violate the spirit of this agreement and plainly invite other nations to compete with us in raising further barriers to trade. A tariff war does not furnish good.  That is just as true today as it was in 1930.

 The national security argument is more of a hobgoblin than a legitimate justification.  If some country wants to sell us products at a discount, why should we refuse?

 Business leaders have spoken out against the tariffs and Congress has made noises about legislative action.  Both should act decisively.  It is said that you get a mule’s attention with a 2X4.  The political analog might get the President’s.



Thinking About Gun Violence

Every time that there is a mass shooting, there is a short lived debate about what to do.  Unfortunately, it soon dies out, in part because those who want action are not as well organized as gun rights advocates, set unrealistic objectives –prevention versus reducing the incidence, and the debate is too polarized.

Certainly, everyone would like to find a way to prevent mass shootings within the context of the Constitution but the problem is too complex for that objective to be achieved.  But that does not mean that such killings and others cannot be reduced.  So, the focus should be on a combination of policies and actions that will make mass killings and others less likely.  What is needed is a serious discussion about guns and gun violence that is based on fact and desire to find common ground.

Florida has the Baker Act which provides to involuntary confinement for mental evaluation.  Local authorities and the FBI had information that could have led to Cruz being confined under that law but the system failed, especially at the local level.  In the case of the Las Vegas shootings, it is not clear that there was enough prior information that could have led to an intervention.    In addition to states having robust gun violence restraining ordnances, there needs to be better public education on behaviors that justify reporting.  For 20 years, Congress has prohibited the CDC from conducting research on gun violence behaviors.  That prohibition has no justification for not investing in knowledge.

Peer reviewed research—Grant Duwe, Michael Rocaque– has shown that individuals with major mental disorders (those that substantially interfere with life activities) are more likely to commit violent acts, especially if they abuse drugs. When we focus more narrowly on mass public shootings — an extreme and, fortunately, rare form of violence — we see a relatively high rate of mental illness.

 The NRA is a major obstacle.  The national headquarters has brainwashed its members that any restraints are the slippery slope to confiscation.  Some members have been quoted as saying owning AR-15 type assault rifles is their god given right under the Constitution.  Anyone who believes that doesn’t understand the Constitution and is possessed by a dangerous thought process.  In writing for the majority in the Heller v DC case, Justice Scalia wrote, “Like most rights, the right secured by the Second Amendment is not unlimited…”. It is “…not a right to keep and carry any weapon whatsoever in any manner whatsoever and for whatever purpose.”  Limiting guns to those used for self defense, hunting, and target shooting is a good start but not sufficient to reduce senseless shootings.  A serious discussion would involve asking why anyone really needs a weapons of war?  Most people do not know that it is still legal to buy pre 1986 machine guns, flame throwers, and Miniguns ( similar to Gatling guns?

However, the licensing requirements are very strict. The process under the National Firearms Act is costly, invasive, and time-consuming. Federal law requires extensive background checks of anyone wishing to own a NFA item such as a machine gun. To purchase a machine gun today, it would take close to a year for the more extensive background check, including submitting fingerprints and a photo.  At a minimum, it would make sense to have the same requirements for AR weapons.

Between 1994 and 2004, there was a ban on assault rifles and high capacity magazines.  Analyses of the ban lead to mixed results because of limited data.  Australia took a series of actions in 1996 that included a ban, new licensing requirements and a buy back program.  In the 18 year period since those actions were taken, mass shootings dropped from 13 to zero.  It is worth analyzing the Australian program to see what aspects apply here.

The goal should be to make it harder for bad guys to get guns & ammunition without unreasonably restraining the ability for good people to have access to firearms for protection, hunting, and sport shooting.   In economics if you raise the cost of something, you get less of it.   Using a more robust background check and licensing system would raise the cost but not make it prohibitive.

The best way to have a real national discussion would be to set up a National Commission to examine the full range of issues involving gun violence leading to  a set of recommendations

Raise the Gasoline Tax

President Trump’s infrastructure proposal has resulted in a re-examination of the role of the gasoline tax with the Chamber of Commerce leading the way in call for a 25 cent increase.  Although the President and the American Society of Civil Engineer claim that our infrastructure is crumbling or is close to failing, the Department of Transportation paints a much different picture, reporting that the highway and road system have changed little in the past decade.

The 1956 Highway Revenue Act created the Highway Trust Fund as a mechanism for funding the interstate highway system and aiding in the finance of rural and urban routes. The tax set at that time was 4 cents per gallon.  It took until 1983 to raise it to 9 cents.  In 1990, Congress raised it to 14 cents and in 1993 is was raised to today’s level of 18.4 cents.  Adjusted for inflation, based on BLS data the 1956 tax would be 32 cents in today’s dollars.

The fact that the tax has increased so slowly over past decades is a reflection of political reluctance to impose any tax that makes clear to those who pay it who is responsible for imposing it.  In the last 15 years, 21 states made no changes in their gasoline tax and only 5 increased the tax by more than 5 cents.  Since the tax is a users fee, the failure to increase it, even at the rate of inflation, means that non drivers are subsidizing those who do.

When Congress passed the Interstate Transportation act in 1991 it allowed the Trust fund to be used for more than highways, roads, and bridges—public transportation and bike paths for example.  Today, the Trust fund spends more than it takes in with the shortfall being made up with general revenue. In the decade ahead, the Fund faces a shortfall of over $160 billion.  So, either general revenue must be used, increasing the deficit even more or there needs to be a program to increase in the gasoline tax on a regular basis.

Congress and state officials have to face up to the inevitable and quit procrastinating.  Every penny increase in the tax will raise about $1.5 billion.  An alternative frequently suggested is a fee based on vehicle miles traveled.  That may sound good in theory given the increase in high mileage cars but it would penalize rural drivers and those who live in the mountain states.  That fee fails the equity tax.

Users need to pay; it’s that simple.



Environmental Illusion and a Public Swindle

According to environmentalists and the Renewable Fuels Association, the ethanol mandate in the Clean Air Act as modified by the Energy Policy Acts of 2005 and 2007 has resulted in cleaner air and a reduction in greenhouse gas emissions.  In reality, the mandate has produced no real environmental benefits while enriching corn farmers, large retailers, and ethanol manufacturers and imposing unnecessary and unreasonable costs on fuel producers and auto manufacturers.  It has also had a negative effect on food prices.

Just recently, the largest refinery on the east coast—Philadelphia Energy Solutions– filed for bankruptcy protection because of the prohibitive costs of obtaining EPA compliance credits—RINs.  According to a Wall street Journal editorial, Philadelphia Energy Solutions has spent $832 million on purchasing credits since 2012.  This is 1.5 times its average annual capital expenditures and twice its payroll costs.

EPA will claim that imposing the compliance burden at the refinery level ensures a high degree of compliance because of the relatively small number of refineries in the US–137.  The problem is that there is a big difference between independent refineries and those that are integrated or large convenience store chains.  The latter have blending capabilities that provide an economic advantage who are also blenders. Independent refineries must buy RIN credits; the others generate  RIN credits through blending that can be banked or sold.  Think about it.  An independent refiner incurs a cost; large retailers like Circle K and Sheetz create an asset through blending that can be sold.

It is only common sense to provide a level playing field for the point of obligation.  Moving this point from the refinery gate to the point of blending might complicate EPA’s compliance tracking but it would not discriminate among refiners.

A much better solution would be to simply abolish the renewable fuel standard since it accomplishes nothing.  The ethanol—oxygenate mandate—is a creation of the Clean Air Act Amendments of 1990 that was designed to secure votes for passage from farm state members.  It was not needed, and Congress knew this at the time, to meet tailpipe emission standards to reduce ozone causing chemicals.  And, it has been shown by analysis after analysis that it does nothing to positively impact global warming or reduce imports.

The renewable fuel standard is simply another example of the Bootlegger and Baptist collusion.  Farmers, commodity traders, and ethanol manufacturers benefit by having money transferred from consumers by embracing environmental benefits that don’t exist and politicians who support the standard are considered good stewards of the environment.  It’s just a sophisticated swindle.

Legal Flim Flam

The City of New York is suing five major oil companies claiming that they have knowingly produced and marketed oil and gas that is causing catastrophic climate damage.  The City’s Counsel is using a non-existing case as part of a PR campaign.  The brief is an example of the lawyer’s rule:  when the law is against you, argue the facts; when the facts are against you, argue the law; and when both are against you, pound the table and yell—a PR stunt.

The heart of the City’s argument is ascribing certainty of knowledge where no certainty exists, impugning the integrity of those who don’t embrace the climate orthodoxy and claiming intentional deception.

The idea that companies and their scientists knew in the 1970s that CO2 from fossil fuel combustion would cause catastrophic climate change is pure nonsense. In the 1970s, there was concern about global cooling as was documented by the first Secretary of Energy, the late James Schlesinger.  Concern about global warming that followed the cooling concern was led by the leaders of the Club of Rome which predicted the end of mankind within decades.  The flawed predictions, based on a complex computer model, were widely criticized and discredited but like all zealots many of the Club’s members moved from Limits to Growth to an impending climate catastrophe without missing a beat. Their predictions of climate catastrophe and James Hansen’s were based primarily on models which continue to overstate warming and climate events as was demonstrated by Professor John Christy in Congressional testimony in 2106.

The limits of models should not surprise anyone since our understanding of many climate processes that are included in models is far from certain and as has been documented by the IPCC—clouds, solar irradiance, oceans, and aerosols, and climate sensitivity.     A major problem with predictions are the complications caused by  the climate system being chaotic.  The father of chaos theory, Ed Lorenz, in 1991 stated, “We note the consequent difficulty in attributing particular real climate change to causes that are not purely internal.”  He also said, chaos theory “will tell us that there is a limit to how far ahead we can predict, but it may not tell us what this limit is.  Perhaps the best advice that chaos theory can give us is not to jump at conclusions; unexpected occurrences may constitute perfectly normal behavior.”

 The City also claims that these companies acting through the American Petroleum Institute (API) and Global Climate Coalition(GCC) engaged in a concerted deception of the public as to the damaging effects of climate change from burning fossil fuels.  That charge is absolutely false.  Neither API nor the GCC ever denied the reality of climate change—called global warming back then–, the fact that CO2 contributed to warming, or that human activities affected climate.  What both organizations did say was that the extent of uncertainty about the impact of human activities did not justify the mandatory emission reductions endorsed by Vice President Gore and the IPCC or the economic damage that they would cause.

The City’s brief would lead a reader to believe that the oil industry refused to take any action on CO2 emissions.  That also is absolutely false.  In Kyoto and subsequently, the GCC and API told VP Gore and White House staff that it would work with the Administration on adopting and promoting voluntary programs, that it would support additional R&D on new energy technologies, and it would work with the Administration to promote the adoption of energy technologies by developing countries.  That offer was rejected because neither the oil industry nor any GCC member was willing to adopt the mandatory actions that were part of the Kyoto Agreement.

One of the most offensive parts of the City’s brief is its slander of the late Fred Seitz who can’t defend his good name.  The City has accepted uncritically the calumny of Naomi Oreskes who among other things slanders Seitz for overseeing research sponsored by Reynolds tobacco.  Oreskes might not be aware but the City’s Counsel should know that a company has a legal duty to have the knowledge of an expert.  Turning to someone who was a past president of the National Academy of Sciences and Rockefeller University would demonstrate that it took this obligation seriously.

The weakest part of the City’s case is ignoring the tremendous economic benefits and progress that fossil fuels have made possible around the world.  It is only necessary to look at the plight of under developed countries where over 1 billion people lack access to commercial energy.  Does the City and its Mayor really want Americans to live that way?

If the Mayor was engaged in more than a public relations campaign, he would ban cars and trucks from New York.  He knows, however, that if he tried to ban cars and trucks from the city he would be recalled and run out of town on today’s equivalent of a rail.

New York has real problems and their neglect is made worse by the Mayor’s folly and the waste of funds on  frivolous litigation.



Delusional Divestment

New York Mayor De Blasio has become the latest activist to join the divestment crowd that is attempting to discredit oil companies.  People like the divestment crowd do a lot of foolish things but selling their stock in protest is more than just foolish, it is an act of economic ignorance.

New York has, according to reports, $5 billion in oil company stocks.  Presumably these are part of the city’s retirement plan for employees.  While $5 billion is a lot of money, it is not a significant amount in terms of the value of oil companies or the amount traded daily in their stocks.  If the Mayor thinks that his stunt will somehow hurt the finances of major oil companies, he knows even less about market forces than a New York taxi driver. New York City’s retirement fund is currently under performing and is underfunded.

Selling stocks in protest as New York plans to do and as some universities have done will hurt them more than the companies whose stock is sold.  For every seller there is a buyer, so the company whose stock is sold only sees a change in ownership.  The seller may sell at a loss as well as incur other costs to complete the sale–transaction costs and the cost of less diversification.  What happens to the proceeds of the sale?  Since the motivation for selling is political and not economic, the seller is likely to purchase replacement stocks that also reflects political considerations.  The chances are that they may not perform as well and may have a higher risk.  If that results in a lower return over time, the beneficiaries of the fund—retirees or scholarship/financial aid recipients are the losers.  In the case of New York, the Mayor is imposing a cost on pension fund participants so that he can participate in a campaign that will not achieve its objectives.  New York City’s shift in focus from meeting or exceeding its return objective to political objectives will only lead to even worse performance.

As a campaigning strategy, divestment is fatally flawed.  As Harvard economics professor Rob Stavins observed, “Divestment doesn’t affect the ability of fossil fuel companies to raise capital: For each institution that divests, there are other investors that take its place. As long as the world still continues to rely on fossil fuels, and consumes them at current rates, the companies that supply them will have a ready market for their products.”  The world is not going to turn away from oil and gas anytime soon because there is no commercially viable substitute for a high density, abundant energy source that is reasonably priced.

Prof Daniel Fischel, professor emeritus of the University of Chicago, in a paper on the subject of divestment–divestmentfacts—wrote,” There is no basis to believe that divestment can affect the stock prices or business decisions of targeted firms. Moreover, there is broad agreement among financial professionals and academics that simple investment rules like divestment from fossil fuel companies cannot generate superior returns. Finally, divestment seems unlikely to affect the public debate or provide an effective tool even for those who strongly feel the need to address climate change.”

Instead of diverting investments from superior to inferior ones and engaging in frivolous campaigns, the mayor should solve the underfunding problem but not on the backs of workers and focus on improving the performance of the city’s retirement fund.







Octane and Gasoline

After my post The Hidden Tax on Gasoline, I was asked to provide more information on octane.  Here is my attempt at a Dick and Jane.

Gasoline and engines are a system.  As engines change so must gasoline.  Today’s engines reflect engineering designed for them to meet strict CAFÉ standards, tail pipe emissions standards and to incorporate technology advances. In general, this has led to higher compression engines which provide better performance, greater efficiency, and more horse power but as a result many of these engines require a higher octane gasoline.

Octane measures a gasoline’s knock resistance or the ability to avoid premature ignition. Most cars still run on regular gasoline–85 %–while cars in the class of BMW and Mercedes and many turbocharged engines require premium or 91-93 octane.  Race cars burn fuel with 100 octane or higher.

Until the mid 1980s, refiners used Tetraethyl lead to prevent knocking.  Lead was phased out for health reasons.  Refiners turned to ethanol or ethers to boost octane.  Ethanol has an octane rating of 115 but has a number of problems which is why it is limited to a 10% blend for most vehicles. Ethers—MTBE—were banned about a decade ago.

As more refineries began dealing with more light—lower sulfur crudes—from imports and shale oils and stricter fuel specifications, they had to find additional sources of octane because gasoline from light crudes have a lower octane rating.

Gasoline is a complex chemical mixture and various refining processes are used to rearrange hydrocarbon molecules to produce higher octane. These include catalytic reforming, isomerization, and dehydrogenation. Probably most refiners use catalytic reforming to produce reformate which is a high octane blending component.  All of these processes add to the cost of producing gasoline.