Oil prices may recover at end of 2015: expert

A gas station in Nantong, Jiangsu province. Continued falls in global crude oil prices have triggered another cut in domestic retail fuel prices, with the nation's top economic planning agency saying that the revised prices will come into effect on Dec 27. [Xu Congjun / for China Daily]

In late 1979, I began work on my PhD thesis, an empirical investigation of the Organization of Petroleum Exporting Countries' surplus and its disposal. It was the end of a decade in which oil prices had undergone two dramatic increases, and most of the geniuses of the day were confidently predicting that they would continue to soar, from under $40 a barrel - a historic high at that time - to above $100. By the time I finished my research in 1982, the price of oil had begun what would become a 20-year plunge. It would not hit $100 per barrel until January 2008.

I used to joke that the most important thing I learned from my research was never to attempt to forecast the price of oil. As 2014 comes to a close, the price of oil has just crossed the $100 threshold again - this time headed down. One of the big questions for 2015 is whether the decline will continue. Despite my earlier cynicism, I do believe that it is possible to make a broad prediction as to where oil prices are headed.

Over the course of my career, I have tried to determine whether there is such a thing as an equilibrium oil price. I have spent many hours trying to guide, cajole, and beg my energy analysts to create a model that might identify it, just as we have for currencies, bond yields, and equities. I have also discussed the idea with industry experts, most of whom believe that one exists, but that it moves around a lot, because it is greatly influenced by the marginal cost of oil production - itself an unstable variable. My conclusion is that a good indication of this moving equilibrium does exist: the five-year forward oil price, or the amount paid for guaranteed delivery of oil five years from now.

A few years ago, I began paying attention to the five-year forward oil price as it compares to the Brent crude oil spot price, the price of a barrel of oil today. I suspect that the five-year forward price is much less influenced by speculation in the oil market than the spot price, and more representative of true commercial needs. So when the five-year price starts moving in a different direction than the spot price, I take notice.

In 2011, after both prices had recovered from the collapse induced by the 2008 credit crisis, the five-year price started to come down gradually, while the spot price continued to surge for a while. This jibed with what I had identified as two big factors fundamentally driving the price of oil: the early days of the exploitation of shale oil and gas in the United States, and the shift in China's economic focus from quantity to quality, which implied that the Chinese economy would no longer be consuming energy at the frenetic rate it had been.

I concluded that there was a fair chance that oil prices were peaking and that before too long spot prices would reverse and start to decline. I thought it was probably the beginning of a move back down to $80 a barrel - precisely where the price has landed at the end of 2014. The spot price has even recently slipped below that level. It was one of my better forecasts.

I no longer make predictions for a living, but I do know one thing: Oil prices will either rise or fall. And I suspect that I know which way they will go. Oil prices may not start rising in the coming months, but, as 2014 comes to a close, forces that will eventually halt their decline are beginning to appear.

The drop in the spot price of oil has taken it significantly below the five-year forward price, which remains close to $80 a barrel. My hunch for 2015 is that oil prices may continue to drop in the short term; unlike in the past four years, however, they are likely to finish the year higher than they were when it began.

The author Jim O'neill, a former chairman of Goldman Sachs Asset Management, is a visiting research fellow at Bruegel, the Brussels-based economic think tank.