Oil price slide gives banks a crude shock

IT’s not just Wall Street banks such as Goldman Sachs that got it wrong on oil.

Kuwait’s emir, Sheik Sabah al-Ahmad al-Sabah, centre, warns the Kuwaiti parliament that a drop in the oil price is hurting the country’s economy

IT’s not just Wall Street banks such as Goldman Sachs that got it wrong. Energy consultants and even the US government did not foresee the sharp slide in oil ­prices, which have tumbled 25 per cent since June.

Goldman shocked the market this week with a call for US oil ­prices to fall to $US70 a barrel in the second quarter of next year. Barclays just released its second price update in three weeks, and other banks are releasing lower forecasts at least monthly.

What did they miss?

The risk of discord within the Organisation of Petroleum Exporting Countries and the possibility that violence in some oil-producing nations wouldn’t interfere with oil production.

For the past three years, oil production in the US has been booming but Brent, the global oil benchmark, has largely held above $US100 a barrel. That’s because sanctions on Iran and unrest in Libya, Nigeria and elsewhere kept oil off the market, allowing supply and demand to stay balanced even as US production grew. Heading into this year, it looked like a pretty good bet to assume that supplies outside the US would stay constrained, and many analysts called for Brent to hold above $US100 again this year.

This northern summer, those assumptions fell apart as Libyan production came roaring back, Kurdish output looked set to rise and Iraqi exports held steady despite an insurgency. At the same time, weak demand in China and the eurozone came into view. The combination of these factors pushed prices lower.

Then, the widely shared assumption in the oil market that OPEC would collectively cut production to keep prices high started to look shaky. Saudi Arabia, the world’s biggest oil exporter, has indicated in recent weeks that it is comfortable with a lower oil price, and prices have fallen in response to these signals.

Citigroup’s global head of commodities research, Ed Morse, predicted in a Barron’s article in March that oil prices could fall to $US75 a barrel in the next five years, a price target that looks far more feasible now than it did then. But even Citi didn’t anticipate that prices this northern summer could fall so far so fast.

The price revisions have been embarrassing for banks, whose customers, including energy companies and traders, rely on these forecasts for their own deals.

The US Energy Information Administration was also caught out. The agency, which releases month-by-month forecasts, called for Brent to average $US102 a barrel this month in the forecast released last December. By July, the EIA was saying that Brent would average $US110 a barrel by this month. In its latest forecast, released on October 7, the EIA settled on a $US97 a barrel average for this month.

But as EIA administrator and former Deutsche Bank analyst Adam Sieminski joked in a presentation in New York last week, his forecasts have been right only about 60 per cent of the time.

Brent is currently trading about $US86 a barrel and has averaged $US88.42 a barrel so far this month, according to Factset.