Michael Lynch | Will gasoline stay under $3 per gallon in 2015?

The government’s Energy Information Administration said today that it expects gasoline prices will average $2.94 a gallon next year, a reduction of 44 cents a gallon from last month’s forecast. This translates into something like $60 billion more in the pockets of consumers, which is good news for the US economy (and the Chinese companies that sell goods here).

Some will scoff at the drastic change in the forecast, arguing that such a big revision cannot be credible, and that an economic recovery next year should bring higher prices. Just a few months ago, a few predicted that crude prices could hit $150 a barrel. Have things really changed that much?

Yes and no. The weak economic outlook recently has definitely reduced expectations of the market balance over the next 12 months or so, and the partial recovery in Libyan production contributed to the bearish atmosphere. But keep in mind that oil prices, unlike those of many other commodities, include a major geopolitical element (security premium), plus perceptions of OPEC behavior.

And the reality is that most predictions of future oil prices are chained to the current price. Few predict big increases or decreases, but usually gradual increases or decreases, so that any sudden change requires a sharp revision in expectations. A decade ago, virtually everyone forecast long-term prices remaining under $30 for two decades or more. In this May’s Annual Energy Outlook (Dept of Energy), only two out of seven forecasts were below $100 a barrel for 2025, and only one (mine) was below $80.

The truth is that in the short run, the same fundamentals can result in widely varying prices, depending primarily on the expectations and perceptions of traders. The nonchalance shown by Saudi Arabia to the recent decrease in prices has certainly helped bring down price forecasts, as has the rise in shale oil production, which continues to surpass projections. But given that Saudi oil production is still quite high, it does not seem likely that they are planning a price war in the near term, just accepting the current (apparent) plateau in prices.

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