While oil and gas prices now are falling after the latest experience with fuel-price volatility, the Global Energy Decision fuels team is focused on modeling an integrated world-wide system of...
Letters to the Editor
of NEMS performance in such a world. Unfortunately, the performance of NEMS is disappointing.
Rode and Fischbeck attempt to explain away these problems with a rational-expectations argument in which EIA’s price forecasts are perceived to be highly credible and gas users act accordingly, building power plants that consume gas and bid up prices. Likewise, this forecast presumes that gas producers would supply this gas because supplies are abundant and inexpensive to deliver.
Rode and Fischbeck’s use of rational expectations to explain why EIA is always one-step behind the market is a demand-side argument that ignores the supply side. In a rational expectations model, consumers and producers knowledgeable of the laws of supply and demand use all available information to rationally anticipate market outcomes. There always will be a divergence between expectations and realizations, but these errors, if rational, will be zero on average. But, as Auffhamer 1 already has demonstrated, the EIA forecasts are not rational and display a significant asymmetrical bias.
By averaging percentage errors over long periods of time, Rode and Fischbeck make the EIA forecasts appear far better than they really are. Using proper measures of forecasting errors, such as the mean squared error, reveals that there is nothing subtle about EIA’s errors in forecasting natural-gas markets. They are large and biased toward optimism since 1998. The fact that the forecast errors reflected pessimism prior to 1998 is yet another illustration of bias. Indeed, both our paper and Rode and Fischbeck’s letter reveal that NEMS has not performed well either during capacity-constrained periods or during periods of surplus. Hence, rather than pointing to any flaws in our analysis, their letter actually supports our conclusion.
Timothy J. Considine, Professor of Natural Resource Economics, Penn State University; and Frank Clemente, Senior Professor of Social Science and Energy Policy; Penn State University.
1. Auffhammer, M. (2006) “The Rationality of EIA Forecasts under Symmetric and Asymmetric Loss,” Resource and Energy Economics, Volume 21, 102-121.
2. Considine, T.J. and F.A. Clemente. (2007) “ Gas-Market Forecasts: Betting on Bad Numbers ,” Public Utilities Fortnightly , July, p. 53-57.
3. Maddala, G.S. (1977) Econometrics (New York: McGraw Hill).
4. Theil, H. (1966) Applied Economic Forecasting (New York: Rand McNally & Co.).