Look to Norway for best crystal ball on oil prices

Of the 14 countries reporting oil price assumptions this year, eight plan to use higher prices than last year in their forthcoming budgets.

Short-term forecasts tend to be more reliable and precise than their longer-term counterparts, if only because they are less likely to be derailed by one-off events. Those venturing to predict the next year's average oil price, however, must still avoid many pitfalls. This is an essential exercise for the governments of oil-producing states as they prepare their annual budgets. Judging from data published this month by the Middle East Economic Survey (MEES), the oil producer with the most skilled team of government petroleum forecasters may be Norway. Its oil price assumptions for four of the past eight years' budgets have been within US$3 per barrel of the actual average price for the year of Europe's benchmark Brent crude oil, and within $6 per barrel for seven of those years. Only in 2007 was Oslo somewhat wider of the mark, undershooting with a $60 per barrel price assumption in a year when Brent averaged $72.44.

The statistical correlation between the Norwegian government's budget assumptions and actual Brent prices from 2002 to last year is a nearly perfect 0.98 (a score of 1 would represent perfection), indicating that the forecasters predicted the annual zigs and zags of the crude market with uncanny accuracy. The Indonesian government's track record is almost as good. In comparison with some more appropriate benchmark than European Brent, the Asian country's performance may have been just as good.

The budget assumptions of the other 16 oil producers surveyed, including 10 from the MENA region, were far less accurate, although Saudi Arabia scored a commendable 0.95 correlation with Brent, meaning Riyadh's forecasters have done a sterling job of predicting the directions of annual price movements. That is only fitting for the OPEC kingpin, which, more than any other oil exporter, presumably wields real market influence.

The Saudi government assumptions, however, have consistently undershot actual prices by more than 35 per cent, and in three years by more than 50 per cent. MEES explains this by suggesting that many governments deliberately undershoot in their forecasts because it is politically easier to explain a surplus than a deficit. The least realistic oil price assumptions came from Algeria, whose government stuck with a flat $19 per barrel crude price for six years from 2003 to 2008 before switching to $37 last year and for this year's budget.

The UAE was not included in the MEES survey. For this year, of the 14 countries that have reported oil price assumptions, eight plan to use higher prices than last year in their forthcoming budgets, five are keeping their assumptions unchanged, and one, Mexico, is using a lower price. Mexico was one of only two countries to overshoot last year, with a $70 per barrel price assumption compared with an actual average crude price of about $62. Norway's assumption was for crude to average $64.08 per barrel last year.

This year, the Nordic nation plans to base its budget on a higher crude price of $72.63 per barrel, which some other oil exporters might find reassuring. Indonesia, currently a net oil importer, must be hoping that its $60 budget assumption is nearer the mark. The Saudi ministry of finance does not explicitly state the oil price assumed in its budget, but according to MEES, available data on Saudi public finances suggest a price range of $43 to $50 per barrel. If Riyadh is intentionally undershooting on its price assumption by 40 per cent, this translates to an implied forecast of $60 to $70 per barrel, a little shy of King Abdullah's stated preference for a $75 crude price.

The Saudi government has said it plans to focus again this year on boosting economic development and improving the kingdom's investment environment, so it must be hoping for prices towards the upper end of its forecast range to help finance its economic stimulus programme. How does Oslo manage to predict crude prices so accurately? One colleague suggests it recruits its petroleum economists from its large population of elves, gnomes and trolls with magical powers. Indonesia's forecasters may also call on forest spirits for guidance.