Natural Gas Price Forecasting: One Explanation for Upward Bias

Abstract

The paper asks why historical gas price forecasts have been consistently too high for the last decade, poses one likely explanation, and suggests an alternative approach that might produce better forecasts. The accuracy of fuel price forecasting, in general, is important because forecasts play a significant role in the production and planning decisions of most major industries. As well, the issue of environmental pollution raises questions about fuel choice. The economics of natural gas will be determined in these and other applications by projections for natural gas prices. We demonstrate that published forecasts have consistently projected substantial growth in price while actual growth has been mild. Next, we propose that forecasts may have been based on a view of gas supply which presupposed that the industry would operate under a short run supply constraint. This explanation also sheds light on poor forecasts which were based on “linkage” or the theory that gas prices parallel those of oil because gas and oil compete in the same markets. Finally, we propose that forecasts should be based on a view of gas supply which accounts for the effects of technological change on offsetting the cost-increasing effects of depletion. This perspective is fundamentally one of long run gas supply.