ValueScope’s Oil and Gas Price Outlook: March 15, 2019
Don’t trust Wall Street soothsayers—if you want to predict the future of oil and gas prices, rely on probabilities and not a crystal ball. Wall Street analysts can run large macroeconomic models to predict future prices, but they are all predicated on numerous assumptions, both macro and micro.
Is there a better source of insight for future oil and gas prices? While futures markets today can’t determine the future for sure, with a little bit of straightforward statistical analysis, they can tell us what market participants expect. All the information needed is readily available—we can examine where futures prices are today in order to predict where spot prices will be in a few weeks or months. This process is useful for estimating the future price range of any traded commodity. It is also helpful as a barometer for the energy market as a whole.
Probability & Statistics 101
Remember the normal curve from your first statistics class? We can use it and option prices to determine the probability that future prices will be within a certain range. In a normal distribution, there’s about a 68% chance that a data point lies within one standard deviation of the mean, and about a 95% chance that it lies within two standard deviations of the mean.
Analysts and traders rely upon option “Greeks” in order to decode the sensitivities of option values to price changes in the underlying commodity. Using option Greeks, we can determine the prices and probabilities that market participants as a whole are expecting, based on their investments.
How can we determine the likely behavior of such a large and often unpredictable group? Because investors are already telling us what they expect by voting with their dollars, not just their intuition or potentially biased expectations.
Crude Oil Outlook
Take a look at the price distribution below, which shows the crude oil spot price on March 15, 2019 and predicted crude oil prices based on option and futures markets. The blue lines are within one standard deviation (σ) of the mean and the red lines are within two standard deviations.
Natural Gas Outlook
We can do the same thing for natural gas, which is currently trading at $2.83 per MMBTU on the Henry Hub. Although more affected by seasonal factors than crude oil, in mid-April 2019, the +/- 1σ price range is $2.60–$3.00 per barrel (68% probability) and the +/- 2σ range is $2.35 to $3.35 per MMBTU (95% probability).
Remember, these option analyses deal in expected probabilities, not certainty—but that doesn’t make it any less useful. If someone asks you longingly if oil will be at $100 again soon, you now can respond with “there is about a 97.5% probability that oil prices aren’t expected to get above $84 before mid-August 2019, so I wouldn’t count on it.” Likewise, if you’re a banker whose borrower needs at least $3.35 natural gas prices in order to meet their debt service obligations in the summer of 2019, the fact that there’s about an 85% chance that gas prices will be lower than this number should help you make a more informed decision— no black magic required.
Tags: Oil & Gas Price Outlook March 2019, Gas Price Outlook March 2019, Oil Price Outlook March 2019
For more information, contact:
If you liked this blog you may enjoy reading some of our other blogs here.