John S. Ferguson: I concur with Mark Williams’ assessment that the proposed KKR/TPG acquisition of TXU through a leveraged buyout (LBO) may “have negative consequences for Texas customers,” which...
Gas-Market Forecasts: Betting on Bad Numbers
Why predictions from the Energy Information Administration may contain systematic errors.
The difficulties of predicting future trends in energy are widely recognized ( see Reference 4). Even the most sophisticated of forecasting models cannot account fully for a myriad of complex and generally uncontrollable variables. Thus, energy policy-makers necessarily must anticipate a wide range of possible outcomes in formulating energy plans.
The issue here, however, is not how difficult it is to predict energy prices, supply, and demand. Our question, rather, is whether systematic biases are built into forecasts, causing them to err repeatedly in the same direction. And the more visible the forecast (and the more likely also that it will be used), then the more likely it is that the error will be compounded in a variety of settings.
In the case of the U.S. Energy Information Administration (EIA), for example, natural gas (NG) data and projections are used widely in regulatory proceedings, energy planning, scientific research, investment decisions, litigation, and legislation. In such cases, systematic bias can have profound socioeconomic implications—not only within the United States but in other nations as well. Indeed, the National Energy Board of Canada regularly includes EIA NG forecasts in its projections. Even OPEC scholars use EIA projections as a benchmark in their research.
This widespread use of EIA forecasts follows the organization’s own view of its nature and purpose. In fact, the EIA has indicated that it designs its forecasts specifically to aid policy-makers by providing “a policy-neutral reference case that can be used to analyze policy initiatives.” However, while the EIA may strive to make its reference case forecasts “policy neutral,” the question still remains: Are they “substantively neutral” in a forecasting sense? In other words, are they removed from the sort of systematic bias in which predictions deviate from actual observations in a distinct pattern?
Over the past decade, it increasingly has become apparent that EIA forecasts for NG differ substantially from actual outcomes. Some commentators 1 have suggested that EIA forecasts present a consistently “optimistic” view of NG that, for instance, underestimate price and overestimate supply. On the surface, this concern has face validity based upon forecasts from the EIA’s Annual Energy Outlook series:
• In 2002, the EIA projected the cost of NG to electric generators in 2006 would be $ 3.82 per thousand cubic feet (Mcf). Actual cost per Mcf was $7.15 (all in 2006 dollars)
• In 2003, the EIA overestimated domestic NG production in 2006 by almost 2 trillion cubic feet—more than the annual production of Oklahoma.
• In 2005, the EIA projected liquefied natural gas (LNG) imports would reach 1,140 bcf in 2006. Actual imports in 2006 were only 583 Bcf—off