Oil Prices to Rise to $70 a Barrel … Or Not?

Boston Group’s Whittaker calls for caution on predictions

30/01/2015 Barcelona

IESE Business School
Predicting prices is almost impossible in today’s climate — Philip Whittaker, Associate Director, Boston Consulting Group / Photo: Emily Fletcher

Philip Whittaker is Associate Director of the world-renowned Boston Consulting Group, whose focus is on predicting oil prices. At the IESE Barcelona 5th Global Energy Day conference this week, he made it clear that doing so with certainty is nearly impossible. There are a range of future scenarios, and serious consequences of the current collapse in the price of oil.

His advice is: be highly critical of any predictions, examine assumptions, and look into the success rate of the predictors; and never discount the possibility of disruptive change.

Price Predictions

Whitaker explained why he didn’t want to simply repeat the usual banalities about the oil market. "You can find the usual stuff with Google," he quipped.

"Never believe someone who tells you they’re sure what the price of oil will be," he warned. And yet despite the difficulties in predicting the price of oil, it’s never been more important to get it right.

Oil’s Wild Ride – And Fall

After a relentless rollercoaster ride from 2007 to 2014, where prices oscillated widely between $20 and $200 a barrel, the current depressed price of around $40 is having profound global effects. It is also the longest price decline in 30 years.

Oil companies are shedding jobs and slashing budgets by 15-20 percent, in line with the decline in their market capitalization. Shell – Whittaker’s former employer – has seen its own market cap plummet by $15 billion since mid-2014.

Industries that support the oil companies are in an even deeper crisis, with service companies seeing share prices falling some 35 percent. Those involved in exploration have been hardest hit – Whittaker described their current situation as "a bloodbath".

Far-Reaching Consequences

Exporting countries such as the Gulf States are facing difficult decisions too. Having grown used to $100 oil, they have been spending accordingly – and are now looking at severe budgetary cutbacks.

Longer-term, cheap oil today may also mean much more expensive oil in the future. Known as the ‘Bullwhip Effect’, cheap oil – at below $70-80 a barrel – and the resultant low profits mean oil companies cut back on exploration, throttling supply further down the road.

Making Sense of It All

Whittaker likened planning for the future in such conditions as: "trying to make rational decisions under extreme uncertainty". Questions managers should be asking themselves when facing such a situation are: whether or not it poses an existential threat to their business, how long the situation is likely to last and what are the opportunities to be had.

These days, you don’t have long to make such decisions, said Whittaker. In addition to foot-dragging, another tendency to avoid is simplification. "Embrace complexity," he said. "Small, seemingly insignificant factors can have big repercussions."

Three Rules of Predicting

Predicting scenarios for the next 36-48 months alone involves around 20 variables – from Chinese demand to European policy on fracking. Whittaker painted three different possibilities for oil prices in the short-term: a ‘Deep V’ of rapid recovery; a slower, cyclical recovery; or, more worryingly, the sustained pain scenario, where the world has to get used to lower oil prices. Whittaker believes the most likely scenario is a slow recovery. But how trustworthy are any predictions, when uncertainty is so rife?

The industry insider had three pieces of advice for managers in assessing any prediction – oil related or not.

Firstly, don’t confuse scenarios with forecasts or predictions. Remember too that none of these are strategies. Secondly, always understand the predictive model being used – and be prepared to be critical of its assumptions. Also, check the track record of whoever is making the prediction – how successful have they been in the past and under what circumstances?

Finally, bear in mind that predictions almost never entertain the possibility of disruptive events. This is an area where Whittaker thinks more work could – and should – be done. As managers, he advised the audience, we need to assess how likely our business is to face disruptive risk – a message that today's managers are getting very used to hearing.