Market participants expect the price of Brent to average around $75 per barrel through the rest of the decade, not much above the current level.

Spot Brent prices have risen around $20 per barrel from their mid-January low, from $46 to $66, an increase of more than 40 percent.

Over the same period, however, futures prices for oil delivered at the end of 2017 have increased just $4.50 per barrel and remain semi-fixed a little over $70.

As spot prices have risen, the slope of the forward curve has become flatter, ensuring prices for 2017 and beyond are almost unchanged (link.reuters.com/jyr64w).

Analysts tend to cite the curve selectively, quoting it when it coincides with their own view and ignoring it when the curve is at variance with their forecasts.

In any case, the forward curve is a notoriously poor predictor. Back in June 2014, it pointed to an oil price around $100 per barrel at the end of 2017. There is no evidence the market can successfully anticipate prices more than about 6 months ahead.

And the curve is not a consensus forecast. The curve is what traders bet against. There will be as many traders who believe prices will be above the curve as below it. For a market to exist there must be uncertainty and a diversity of views.

That said, the curve can provide some indication about the state of market views on average. At the moment it indicates many market participants think oil prices will trade around $75 for the next few years.

That level corresponds roughly to most estimates of the breakeven price needed to sustain modest growth in global oil production.

Published estimates by industry sources range from a marginal cost of $55 or $65 to as much as $75 or $85 per barrel.

Forward prices have settled in the center of this range, which suggests marginal cost estimates are acting as an anchor for expectations.

Those expectations appear roughly reasonable. North Dakota’s Department of Mineral Resources estimates the state’s shale producers need at WTI price of $65 per barrel to sustain their current output of 1.2 million barrels per day.

Cost reduction throughout the supply chain should help lower the marginal cost of production in the next 2-3 years, which could pull medium-term prices below their current level.

On the other hand, if Brent prices stabilize around $75, growth in oil demand, which has been subdued, is likely to accelerate, tending to push up prices in the medium term.

There is no such thing as an "equilibrium" price in the oil market. Supply and demand are characterized by long lags and deep cycles which ensure prices are always unstable in the medium and long term.

But as a very rough estimate for planning and investing purposes, assuming an average of $75 per barrel over the next 3-4 years is reasonable (though that could just be me invoking the forward curve as it agrees with my own assessment).

Prices much above that level look unsustainable because they would encourage too much new supply, especially from the shale sector, and restrain demand.

Prices much below look equally unstable because they would not sustain healthy capital investment and boost demand too much.

The only certainty is that predictions about oil prices are always wrong (newspapers and academic books are littered with dozens of forecasts that went badly awry and it is hubris to assume this time will be any different).

But if you want a figure to plug into a medium-term model, $75 is not a bad place to start.

Source: www.reuters.com

Please leave comments and feedback below