The American Petroleum Institute says futures markets are a useful snapshot of what market participants expect but have been poor forecasters of actual prices.
It explained, "Those expectations, although they may reflect the best information available at the time, are based on incomplete and changing information."
In a recent analysis, API said, "Petroleum futures trading, as a source of public information on widely traded commodities, provides a useful window on petroleum markets.
"Since contracts are traded for delivery for a series of months into the future, it is logical that one important component of the prices at which futures contracts trade would be market expectations about prices in the future."
It said current prices for futures contracts have been showing a steep decline for crude oil for delivery several months out, as compared with nearer months-"a strong indication that market participants, right or wrong, on average expect a significant price decline for crude oil over the next several months."
API notes that in futures market terminology, when long-term prices are lower than the nearest contract, the market is in "backwardation," and when they are higher, it is "in contango."
It said a review of markets for the past 12 years shows that the degree of backwardation experienced in early 1997 is not unprecedented.
"There was similar backwardation in January 1991 during the Persian Gulf crisis, when prices had risen sharply after the invasion of Kuwait by Iraq, and in January 1986, when a dramatic increase in Saudi production was in progress and prices were already starting to decline."
API said although futures price patterns have tended to correspond with the actual direction of prices in recent years, frequently they have not.
"Even when they have, it has only been directionally. Thus, as a precise predictor of prices in the future, the futures market has often done quite poorly."
It noted that about a year ago, crude for delivery in December 1996 was trading at less than $18/bbl, but the contract actually settled at the end of December for more than $24/bbl.
Similarly, from mid-1992 to early 1996, crude oil futures prices for delivery a half-year out had a roughly 40% chance of differing from the closing price by $2/bbl and a 10% chance of being off by $4 or more."
API said it is not contradictory that the term structure of futures prices historically has tended, more often than not, to correspond with general price trends but has failed to accurately predict specific price levels.
"The very uncertainty in prices is one of the factors that makes futures markets viable. Without price uncertainty, producers and consumers who use the futures market to reduce the risk of price changes (hedgers) would derive no benefit from trading futures, and those who trade with the hope to gain from market volatility (speculators) would also have no reason to trade.
"Thus, if market participants' expectations were always accurate, there might very well be no futures market."
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