This could have been an April Fools post, except that it’s not a joke.  On Monday morning, Bloomberg News reported that the financial whizzes at Seven Days Ahead, a firm that gives market trading advice to hedge funds and banks, were predicting that oil prices would fall this week:

Crude oil’s two-month rally is unlikely to continue after the commodity slid under a so-called Fibonacci level, according to technical analysts Seven Days Ahead…the upward trend is broken…”The risk is for short-term weakness.”

Sounds like gobbledygook, but hey, they’re experts, right?

Or maybe not.  Defying predictions, oil prices shot up over $2 per barrel on Monday, rising from $79.75 to $81.92 per barrel.  By the time the closing bell rang yesterday (Thursday), they were up an additional $3.  Spot prices for crude oil now stand at $84.87—a gain of $5 in 4 days, after the pros had bet that oil prices would stagnate or sag.

I’m not trying to pick on Seven Days Ahead. I’m just pointing out that oil prices are volatile, and are very difficult to predict—even for seasoned financial professionals who have a lot to lose from bad predictions.

The problem isn’t that price predictions are bad, and should be better; I’m not sure it’s even possible to predict future prices with any confidence. Instead, the real problem comes when policymakers try to read too much into “expert” predictions. 

  • Policymakers fall into this trap all the time:  to figure out how energy policies might play out in the real world, they rely at least in part on experts’ forecasts of energy prices.  But those forecasts can be wildly wrong—leading to all sorts of boneheaded policy outcomes.  The mid-1990s trend towards bigger and bigger vehicles was, at least in part, the result of predictions that cheap oil would continue indefinitely, which took the wind out of any effort to raise fuel efficiency standards.  (Prevailing politics didn’t help, obviously, but it was especially easy to pooh-pooh efforts to boost MPG when it seemed like gas would be cheap forever.)  But “unforeseen” price spikes helped send the entire economy into a tailspin—dragging down not just the auto industry, but also the consumers and homeowners whose budgets got squeezed by rising transportation costs. 

    Things can cut the other way, too.  As we’ve said many times, we think that a carbon tax is a fantastic idea, since it taxes things we don’t want (oil dependence, climate disruption).  But if the goal is to reduce carbon emissions on a particular schedule, carbon taxes require some guesswork about future energy prices.  Consider, for example, that a $10 per ton tax on CO2 translates into just $5 per barrel of oil, give or take.  So if oil prices happen fall from today’s level to what they were just this past Monday—or more generally, if energy prices fall faster than carbon prices rise—a $10/ton CO2 tax might not actually reduce energy consumption from today’s level.  Yes, a carbon tax would reduce emissions below where they’d otherwise be—but perhaps not enough to make a dent in actual emissions.

    That’s probably been the main reasons we’ve been boosters for a carbon cap:  it takes a lot of the guesswork out of climate policy.  The cap acts as a self-adjusting tax, guaranteeing emissions reductions no matter what happens to oil prices, or interest rates, or economic growth. That’s not to say that I wouldn’t be delighted to support a well-structured carbon tax!!  But in a world of volatile and unpredictable energy prices, there’s some value to a policy that doesn’t rely on price predictions at all.

    UPDATE:  As I write, the “spot” price for crude is up another $1.70—seven days after the day that “Seven Days Ahead” predicted that prices had temporarily maxed out.