Predicting the price of crude oil

[madness]

I am a (mathematical) physics student doing a project on predicting the price of crude oil, and was hoping someone here could help point me in the direction of some good resources (books, websites, journals etc). I am especially interested in resources which model things mathematically. The project outline is very vague, and I'm really just looking for somewhere to start at the moment. Thanks.

 

[CRGreathouse]

http://en.wikipedia.org/wiki/Efficient_market_hypothesis
http://en.wikipedia.org/wiki/Technical_analysis

 

[John Creighto]

I'm not an Economists but I'd use basic principles of supply and demand. However, for the demand equalization I'd use a linearized utility function constrained by the GDP.

The Unitlity would be Given by the following equation:
1) $$U=U_o + (\nabla _x U)(X-X_o)$$

Where:
$$U$$ is the Utility
$$U_o$$ is the utility at the point of linearization.
$$X$$ is the quality of goods purchases
$$X_o$$ is the quality of goods purchases at the point of linearization.

For $$X_o$$ I'd use trends in demand.

Since we can't measure utility perhaps set it to one and estimate $$U_o$$ and $$(\nabla _x U)$$ from historical data.


The Supply funciton is more straight forward:

2)$$S=S_o+ (\nabla _p S)(P-P_o)$$
$$S$$ is the supply
$$S_o$$ is the supply at the point of linearization.
$$P$$ is the price of the good.
$$P_o$$ is the price of the good at the point of linearization.

I'd Base $$P_o$$ on the price given in the futures market. I'd set $$S_o$$ based on the growth projection given by industry (i.e. planed future projects)

$$(\nabla _p S)$$ is the gradient of the supply with respect to price. I'd probably just estimate this from historical data although alternatively one could look at how the marginal cost of production varies with the price and remember that the in equilibrium the marginal cost of production should equal the expected rate of return (say about 8%). Also remember that oil companies usually plan production based on a lower cost of oil then the market cost.


The GDP is given by:

3)$$(GDP)=(GDP)_o+(X-X_o)^T(P-P_o)$$
$$(GDP)$$ Is the GDP
$$(GDP)_o$$ Is the GDP at the point of linearization.

Again I'd set $$(GDP)_o$$ based on the growth trends in GDP.

And the total value of demand is given by

4)$$(P^TX)=(P^TX)_o+(X-X_o)^TA(P-P_o)$$

equation 3) must equal equation 4)

$$A$$ reflects the marginal savings rate. Eignvalues greater then one suggest negative savings and eigenvalues less then one suggest positive savings. Note that a Positive savings rate means a negative money multiplier and a negative savings rate means a positive money multiplier.



So my basic proposed model would linearize about the trends and then check based on supply and demand weather we expect these trends to continue.

Edit: I think my proposed method is kind of like a predictor corrector method. Also notice the sensitivity of the equations to A. A small change in the savings rate could dramatically effect the equilibrium.

 

[madness]

Thanks for the replies, unfortunately they aren't exactly what i was looking for. The aim of the project is really to conduct some kind of literature review on the subject and compile a report based on various sources. The first reply is probably not mathematical enough to be acceptable for this project, and the second hasn't cited any academic sources. I'm finding it very difficult to actually find any detailed mathematical models used to predict the price of crude oil. I'm sure they are out there somewhere...

 

[mgb_phys]

Anybody with an accurate model for world oil prices wouldn't be publishing it - they would be sitting in a house made of diamonds while Bill Gates and George Soros mowed their lawn.

Then on top of regular supply-demand laws you have the political aspect. What if Obama dissed Celine Dion at the inauguration and Canada imposed an oil embargo while Venezuela invaded Iran.

 

[madness]

I didn't say I needed a perfect model to predict the price of crude oil. I'm looking for mathematical models, which I assume exist and have been published, otherwise my supervisor wouldn't have set the project. Supply and demand, the role of speculators etc are all things which can be modeled mathematically, and the reliability of such models is to be evaluated as part of the project.

 

[CRGreathouse]

Anybody with an accurate model for world oil prices wouldn't be publishing it - they would be sitting in a house made of diamonds while Bill Gates and George Soros mowed their lawn.

Yeah, that was the reason I left a lin to the EMH in post #2.

 

[Proton Soup]

good luck with your math and market theories. oil isn't a free market.

http://en.wikipedia.org/wiki/OPEC

 

[madness]

So everyone agrees that I have been given an impossible project then? It is not even possible to find someone who has attempted to model oil price trends mathematically?

 

[mgb_phys]

Over the short term supply-demand equations will work. oil will generally track other economic indicators since it's demand is linked to industrial output (to fuel factories) and wealth (to run cars).
Longer term there will be hiccups due to artificial shortages (the 70s oil embargo following the Arab-Isreali war) and new discoveries (the North sea or oil sands coming on line)

 

[madness]

I have to stress again that finding a model which works in the long term in not my aim. I need access to any work in this area which I can evaluate and compile a report on.

 

[mheslep]

I have to stress again that finding a model which works in the long term in not my aim. I need access to any work in this area which I can evaluate and compile a report on.

Madness - The US EIA appears to be far and away the leading voice on short term oil predictions; a task such as you have described must start there.
http://www.eia.doe.gov/emeu/steo/pub/gifs/Fig1.gif
They steadfastly predicted falling oil prices last Summer when oil was topping $150/bbl and the manic were predicting $200/bbl. EIA predicted the current oil surplus; they didn't capture the sharpness of the decline, but that surely must be assigned in part to the credit crash. EIA representatives also testified as much to Congress last Summer (Rep Markey's committee) and held to them despite incredulous responses from Markey.
http://www.eia.doe.gov/pub/forecasting/steo/oldsteos/jun08.pdf
They're now predicting a price rise to $50-60/bbl by 2010.

In particular, you'll want to dig into their petroleum supply and demand model equations here:
http://www.eia.doe.gov/emeu/steo/pub/document/textsu.html
http://www.eia.doe.gov/emeu/steo/pub/document/textpt.html

 

[stewartcs]

Here is some historical price information that may help.

http://www.oilnergy.com/1obrent.htm#since88

CS

 

[Potential]

T. Boone Pickens may provide the information you are after. He should have a public website which is also advertised on TV occasionally. In order for him to discuss oil topics with congress, surely he had to invest personal funds in public research. If so, these documents should be available, maybe due to the Freedom of Information Act.

 

[Phrak]

How does one model OPEC inclinations and middle east termoil in a predictive manner?

 

[Potential]

How does one model OPEC inclinations and middle east termoil in a predictive manner?

One possible way would be to implement an artificial neural network to find non-linear patterns of historical oil data.

 

[DrClapeyron]

How does one model OPEC inclinations and middle east termoil in a predictive manner?

You could take into account such things as US food exports to the middle east, weapon sales to the middle east, and short and long term US Treasury interest rates. I would put emphasis on interest rates and financial derivatives in general.

 

[Phrak]

You could take into account such things as US food exports to the middle east, weapon sales to the middle east, and short and long term US Treasury interest rates. I would put emphasis on interest rates and financial derivatives in general.

That's an interesting selection. How does food exports enter the relationship? The prime rate is currently driven by US internal economic concerns. If you mean the difference between long and short term rates, how would this be an indicator? Movement of weapons is interesting, especially if it's Iran whos doing the outbound moving. Weapon sales to Iran could be a good indicator of Iranian intent, with a good time margin, as well.

 

[JakeA]

http://www.google.com/search?hl=en&q=oil+pricing+models&btnG=Google+Search&aq=f&oq=

One thing's for certain. The price of oil is very inelastic, meaning that a very small supply/demand disparity can cause a massive swing in price in either direction. That part of the model is what's really interesting, and it seems has not been modeled very well yet.

 

[JakeA]

Weapon sales to Iran could be a good indicator of Iranian intent, with a good time margin, as well.

Weapons sales to Israel would be a much better indicator of violent intent and future conflict. The price of oil did in fact surge during Israel's invasion of Gaza, and it hasn't made it back down to where it was before the invasion.

The "conflict" variable doesn't seem to be very useful anymore, though. Saudi Arabia, probably the lead OPEC nation on this issue has stated it sees no utility in attempting to use oil as a political weapon. Even if they wanted to, it's doubtful they could get away with it. Too many oil suppliers, and they all need the money.

Things like blowing up oil pipelines and other forms of sabotage normally have a regional effect, but are nowadays less likely to make it into macro pricing events.

 

[mheslep]

Weapons sales to Israel would be a much better indicator of violent intent and future conflict. The price of oil did in fact surge during Israel's invasion of Gaza, and it hasn't made it back down to where it was before the invasion.

??
Crude Oil Nymex close: $/bbl
12/24: $38
12/27: Israel attacks Gaza
12/29: $43
1/6: $53 (peak in 2009)
2/10: $38

 

[Proton Soup]

israel makes a lot of its own weapons, you know. here's one example: http://www.elbitsystems.com/

 

[JakeA]

mheslep, you're right. The effect would be very slight at best, but most likely non-existent.

http://tonto.eia.doe.gov/dnav/pet/hist/rbrted.htm

On this chart, if you look at the price right around Christmas, Dec 25, you'll see that spot European crude is hovering at around $34. I would say that the price went from $34 to $38. But there are other factors involved in the price. For instance oil inventories were down yesterday, which would have put upward pressure on prices:

http://uk.reuters.com/article/oilRpt/idUKN1060341120090210

Again, I would agree that other than creating short lived spikes, purely political events don't have much impact on oil prices these days.

But if you're looking to make money on oil spikes, I would personally look at the actions of the US and Israel, both starting or being behind every single war in the Middle East for the last decade. Look for political situations in those countries. Iran isn't going to invade Israel, but Israel is chomping at the bit to invade Iran.

You might have been able to predict the invasion of Gaza. Israeli elections coming up. New president in the US. It was a temporal vortex that was inviting some sort of military action against Gaza.

I'd like to stay away from a political discussion of who's right and wrong in these conflicts, but if you're building a mathematical model, my suggestion is to not build in your own personal political biases. I need to remind myself as well of that suggestion all the time.

 

[Phrak]

I'd like to stay away from a political discussion of who's right and wrong in these conflicts, but if you're building a mathematical model, my suggestion is to not build in your own personal political biases. I need to remind myself as well of that suggestion all the time.

Yes, you should.

 

[DrClapeyron]

In 1973 OPEC placed an embargo on exports to the US. The effect caused a decades worth of high inflation. Though the embargo lasted less than 6 months motivation stemmed from a three week war between Israel and Egypt. However this time period marked the transition between oil exporter to oil importer for the US. It seemed to have had a major impact on US inflation and global oil prices in general.

While high inflation and high oil prices appeared to harm the US economy in the short run, certain factors played into the US's advantage. The US was able to finance the price level change (inflation) with US government debt (now ~$9 trillion, ~50% foreign held). The net effect of rising crude oil prices, even at the levels seen in 1973, 1979 and 2005-2006 do not seem to have harmful effects on the US economy.

However, in 1986 the Saudis doubled their oil production output to 6 million barrels per day. Prices in 1986 dropped from $30/barrel to less than $10/barrel. At the time the Soviet Union was the largest producer and exporter of oil and was financing a huge war in Afghanistan with proceeds from oil sales at the $30 level. The nearly overnight drop bankrupted the Soviet Union and they were forced to withdrawl from Afghanistan and disband the Union.

1987 the US stock market crashed and Greenspan ordered the Federal Reserve to increase the money supply. In 1989 there was a savings and loan (S&L) crisis which exposed the FDIC for being unable to 'insure' accounts as it at promised it would do. The S&L crisis was tied to Regulation Q which set interest rate levels on US commercial(?) bank accounts. Regulation Q was repealed on account of rising eurodollar rates. etc, etc, etc.

Now in 2009 after oil prices have dropped bellow $50 for the first time in five years the Federal Reserve and US Treasury have suddenly announced that there is a 'financial crisis'. This crisis it seems will only be solved by injecting liquidity (money) into the markets (the banks which have reportedly failed, i.e. Goldman, Lehman, etc).

A brief history of oil prices over the past 35 years but no where near complete. Why should you take into account US interest rates? Good question.

 

[stewartcs]

A brief history of oil prices over the past 35 years but no where near complete.

A not so brief history can be found here for those interested:

http://www.emnrd.state.nm.us/OCD/timeline.htm

CS

 

[Adrock1795]

The price of oil you always hear on tv, is a completely financially settled instrument. What they are trading is the future price of oil. Every price movement is motivated by a gamble for a financial gain, or fear from a financial loss. Price volatility determines the accuracy of the speculator.
http://www.econstats.com/fut/xeiad_em1.htm
http://www.econstats.com/fut/xnym_ew1.htm

 

[CRGreathouse]

Here are some papers discussing the modeling of oil prices:
http://www-personal.umich.edu/~lkilian/paperlinks.html