Forget Short-Term Noise: Oil Prices Are All About the Long-Term Trend

Well, it is year end 2024, time for all respectable pundits to earn their keep by making predictions or by bloviating on the latest topic somebody has latched onto.

So, we approached our favorite pundit, Mr. Question Man, to make his contribution to popular seasonal wisdom. Here is the interview.

Q: What is the direction of oil prices and does it matter?

A: You remember the comment by John Kenneth Galbraith about economists making projections? He said that their only value was to make astrologers look good. However, I will answer. Oil prices will wobble around the trend line as they have been doing for the past half century. That’s called reversion to the mean. And it does matter—or at least it mattered for the last fifty years. (See Fig.1.)

Figure 1. WTI spot price for oil ($/bbl in current dollars) as of year end

The steady rise in the price of oil, though, may reflect little more than inflation. Figure 2 presents the real price of oil (deflated by the consumer price index). In effect, the real price of oil has not changed over 50 years. It has wobbled around the trend line, always reverting to mean after wandering too far. From 1974 to 1999 the price of oil rose 3.4% a per year and the consumer price index 4.7% a year. From 1999 to 2024, the price of oil rose 4.0% a year and the consumer price index 2.6% a year. For the entire 1974 to 2024 period, the price of oil rose 3.7% per year and the consumer price index 3.7% per year. In other words, if you wanted to make a bet on a number for the long term trend in oil prices, should you just bet on the rate of inflation and skip the econometric analyses? (It reminds me of that defining moment in grad school after the econometrician filled the entire board with equations to explain the direction of the economy and another professor interrupted to say, “I can predict just as accurately using a ruler.”) Get the message?

Figure 2. Real price of oil (WTI spot price in 1982-84 dollars) as of year-end.

Q: No. What’s the point?

A: The price of oil jumps around short term because of economic activity, weather, natural disasters, wars, shipping interruptions and OPEC attempts to cut or increase supply, most of which is unpredictable. But we do know that the Chinese and European economies are weak and we might guess that our next president would push for greater U.S. production if OPEC decided to reduce supply by too much, so barring all the other potential disasters, we’d bet against a short-term price recovery. But oil companies should not make investment decisions based on short-term price swings.

Those investments, if properly made, last for decades. The best we can say about the future, with any certainty is that the rate of population growth is falling faster than previously expected and that a huge amount of money has poured into the development of electric and hybrid vehicles, which will eat into the oil industry’s biggest market, transportation. Beyond that, whatever goes into the econometric model is just highly paid guesswork, designed to make astrology look good. Why not project the long-term trend as $70 plus the rate of inflation, make investment decisions on that basis, and accept that prices will oscillate around that number?

Q: You are proposing to use a ruler to project oil price long term?

A: Why not? You have a better idea?

Q: What about the Trump administration’s impact on global climate policy worldwide?

A: Well, Trump could pull out of international agreements and refuse to put up any money to help people hurt by climate change in poor countries. At the same time, the US is not the big player it once was:

Table 1. U.S. percentage of global:

If American industry were encouraged to return to production of 19th and 20th century products and services (such as coal-fired electricity or internal combustion engines) via regulation, subsidies and tariffs, this would create an interesting dilemma for American industry. They would have to develop product lines for just 15% of the world market, thereby losing economies of scale derived from developing global platforms for production. Do you really want to invest in companies that turn away from modern technologies and produce products for a limited and declining market?

Q: We have only a few minutes left, so let’s talk about the energy crisis?

A: What crisis is that?

Q: The ones those governors were talking about on the radio, you know the one that would require Utah coal as part of the solution, as a result of the expected huge demand for electricity by all those data and AI centers. They are afraid there won’t be enough electricity for those places.

A: Why are we wringing our hands about this? The five big companies likely to own, run and profit from AI and data centers have combined sales of almost $1.8 trillion and net profit of almost $0.4 trillion  — roughly four times the sales and six times the profit of the entire electric industry. If these companies are so desperate they could build a private, low-carbon, underground electric network of their own, which, I would guess, would cost $0.5 to $0.7 trillion. They certainly can afford it. This is a made-up crisis generated because the potential data center beneficiaries are looking at large increases in electrical demand and they want someone else –utility ratepayers—to foot the bill?