Rabah Arezki, Douglas Laxton, Armen Nurbekyan, and Hou Wang
Oil prices have dropped dramatically focusing the attention on the short run. This article takes a longer view. It argues that the oil market is shaped by forces pertaining to demand and supply. A simple model integrating these forces is presented as a useful tool to explore likely scenarios. Notwithstanding the level of uncertainty surrounding the evolution of both demand and supply forces, simulations point to the emergence of supply shortages suggesting that available forecasts predicting persistently low oil prices may be too optimistic.
Oil prices have fallen by over 50 percent since June 2014. Much has been written about what triggered this slump, and the relative role of supply and demand factors. Considering that price elasticities are extremely low in the short run, disturbances, such as the shift in strategy by OPEC, can result in sharp fluctuations in prices. Simple extrapolations of recent trends would give a very misleading picture of future oil prices over the longer term. The long-run price elasticities are considerably higher, as both consumers and producers change their behavior, and adopt new technologies, and underlying developments in demand and supply come to the fore. While there is uncertainty about the evolution of these developments, there are known elements such as geology on the supply side and demographics on the demand side. Technological innovation, responding to economic incentives (e.g., the advent of shale exploitation), and to policies aimed at reducing greenhouse gas emissions (e.g., the emergence of alternative energy sources) also will play a key role in shaping the oil market.
The present article discusses the relative strength of those forces and their interplay. It also presents exploratory simulations using a novel oil model developed at the IMF to study the implications of possible future trends in supply and demand. A simulated baseline path suggests that the oil price could reach US$80 (adjusted for inflation) per barrel in 2020 and US$100 in 2025. These projections should be seen as indicative of the underlying tendency of oil prices that would prevail, barring radical changes in the future path of technology and global economic growth. Of course, geopolitical disturbances or strategic maneuvering could cause short-term movements around any such path. However, the model does provide an analytical tool to explore the consequences of a variety of scenarios.
This article attempts to answer the following questions:
What will drive demand forces?
What will drive supply forces?
What do model-based scenarios tell us?
Benes, J., M. Chauvet, O. Kamenik, M. Kumhof, D. Laxton, S. Mursula, and J. Selody. 2015. “The Future of Oil: Geology versus Technology,” International Journal of Forecasting. 31(1): 207–221.