Price Forecasts vs. Futures: A Reserves Evaluator’s Perspective

January 26, 2015 by

Editor’s Note: While VISAGE rebranded to VERDAZO in April 2016, we haven’t changed the VISAGE name in our previous blog posts. We’re proud of our decade of work as VISAGE and that lives on within these blogs. Enjoy.

Guest Blog by: Tyler Schlosser, P.Eng., Director of Commodities Research, GLJ Petroleum Consultants

Using VISAGE linked to GLJ’s pricing database, we can quickly plot past Brent Crude forward curves (the purple lines) along with historical prompt month prices (the black line). This demonstrates how responsive forward curves are to current market sentiment. While forward curves do not truly represent spot price forecasts, they do tell us the prices that market participants are willing to agree to today for delivery in the future, and are often compared to industry forecasts. It can be seen that following dramatic changes in prompt month oil prices, the whole forward curve often shifts up or down in a big way.

In contrast to the often volatile futures pricing, the purpose of GLJ’s price forecast (green line) is to provide a reasonable basis for the valuation of our clients’ oil and gas assets. When big swings in prices occur, it is important for us to make a measured response and not overreact to recent market moves, particularly regarding the longer term parts of our forecast. While extraction costs will follow prices down in the near term as service companies compete for business, the impact of recent price volatility on long term full-cycle costs is not immediately obvious. GLJ’s forecast also acknowledges the mean reversion tendency of oil prices – particularly following large, rapid price movements – and reflects the opinion that this mean reversion is more likely than a scenario where spot prices follow the current forward curve for years to come. In each new price forecast we publish, both our near term and long term outlooks are reviewed.

Brent-Crude-Price

Another price forecast, which is used as the basis for oil and gas asset valuation in SEC (United States Securities and Exchange Commission) filing, is a constant price forecast that reflects an arithmetic average of the first-day-of-the-month prices for the trailing twelve months. When large price movements happen, this forecast can often be far removed from current market prices and expectations. At year-end 2014, this forecast is much higher than market prices. If we see a strong price recovery late in 2015, next year’s SEC price forecast could be substantially lower than market prices at that time.

While it’s certain no forecast will be correct, it is important to understand the pricing assumptions behind published reserves volumes and values in order to put press releases, corporate presentations or company comparisons in their proper context.

It should be noted that the SEC price forecast (blue line) reflects a zero inflation rate while the GLJ forecast reflects a two percent inflation rate. The forward curves incorporate many assumptions that differentiate them from true spot price forecasts, which, in theory, include the market’s anticipated inflation rate.

…by Tyler Schlosser, P.Eng., Director of Commodities Research, GLJ Petroleum Consultants

I hope that you found this insightful.

If you have questions or comments please contact info@verdazo.com

Thanks for reading. I welcome your questions and suggestions for future blogs.

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About VISAGE – visual analytics for the petroleum industry
VISAGE analytics software equips operators and analysts in the petroleum industry to make the most valuable and timely decisions possible. VISAGE brings together public and proprietary oil and gas data from multiple sources for easy to use interactive analysis.