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My Year-End Forecast: There Is No Future For Prediction

Dominic Lawson, The Sunday Times

The US should close down its energy supply-and-demand forecasting department. We should do the same with our own “experts” at the Department of Energy and Climate Change.

You don’t often find comic gems in the business sections. Last week, however, an earnest financial reporter produced one unintentionally when he wrote: “No one expected this sudden sharp drop in crude oil prices.” As Homer Simpson would say: “D’oh!” It was sudden and sharp because it was unexpected. Or to put it another way: if people had generally expected the price to fall, it would already have done so.

There is a serious point, here, however, one that should concern anyone who pays money to read expert predictions — and we are now at the time of year when the forecasting business is at its height. The serious point is that forecasting tells you nothing about the future.

When it comes to the oil price, the forecasters might have had all the best computers and market models at their fingertips. But unless they could read the mind of the Saudi Arabian oil minister, Ali al-Naimi, they were clueless. Al-Naimi, presumably after discussions with King Abdullah, decided earlier this month that Saudi Arabia would not cut its oil production to keep supply and demand in rough equilibrium. The result: a halving in the price from the summer’s level of $120 a barrel.

A range of theories is now being offered to explain this. The Saudis want to punish the Russian president, Vladimir Putin, for supporting Syria’s regime (which they hate); the Saudis want to make American shale oil uneconomic; the Saudis want to maintain their share of the oil market, whatever the price.

The only certainty is that none of the handsomely rewarded energy market forecasters has the slightest idea, just as they had no idea that the Saudis would refuse to act to stop the oil price collapsing (which is odd, because the kingdom acted in exactly the same way in the oil-oversupply of the mid-1980s, as I recall from my time as energy correspondent for the Financial Times in that era).

It’s not just over the short term that even the most authoritative forecasters are hopeless. The US Energy Information Administration (EIA) gives the most widely reported five-year forecasts of supply and demand, but according to Lowell Field and Steve Yetiv in their article Why Energy Forecasting Goes Wildly Wrong, the EIA’s forecasts have consistently been “off by staggering margins”.

Field should know: he was a senior energy analyst with the US Department of Energy, of which the EIA is part. He defends his former colleagues’ failure to predict each and every “Black Swan event” — the 1973 Arab-Israeli War and the Arab oil embargo, the Iran-Iraq War, the 1985-6 collapse in oil prices, the war in Iraq, the massive increase in Asian oil demand, the fracking revolution, the Canadian tar sands boom — on the grounds that “this is not because forecasters are idiots. It’s because it’s simply not possible to predict this stuff.” But if it’s not possible to predict the things that cause dramatic change, then the US should close down its energy supply-and-demand forecasting department.

By the way, we should do the same with our own “experts” at the Department of Energy and Climate Change. The government had based its billions of pounds of subsidies for “renewable energy” on predictions that the price of gas would only rise and I had been told by successive energy ministers that the US fracking revolution would have no depressing effect on oil and gas prices outside America. They were so mesmerised by their wretched forecasts that they failed to examine the real world (or thought that the law of supply and demand could be revoked by an act of political will).

In the wider economic sphere (of which oil and gas are just a part), official forecasts are no better. As a member of the Bank of England’s staff recently told me, with endearing frankness: “Everyone seems to think our economic forecasts should be the best, but I don’t see why.” Indeed, at the start of the year the Bank’s governor, Mark Carney, abandoned his policy of “forward guidance” on interest rates barely five months after he had announced it. The reason was that the unemployment rate forecasts on which it had been based turned out to be much too pessimistic. Or as the Financial Times reported: “Commenting on the huge errors in the central bank’s forecasts, Mr Carney said, ‘If our forecast is going to be wrong, it’s better to be wrong in that direction.’”

One reason why the chancellor, George Osborne, had abandoned the Treasury’s control of a central economic forecast and contracted it out to a new Office for Budgetary Responsibility (OBR) was that he was aware how vulnerable to ridicule those in his position are when the Treasury’s forecasts turn out to be (to use the technical term) rubbish.

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