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EIA Releases First Outlook of Oil Price Uncertainty

October 7, 2009

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The U.S. Energy Information Administration announced the first results of its Energy and Financial Markets Initiative, an effort launched in September to better understand what drives energy prices
. The effort is spearheaded by Dr. Richard Newell, the agency's new administrator. (The EIA is part of the U.S. Department of Energy.)

"Starting this month, EIA is including a quantitative measure of price uncertainty based on options market transactions in our monthly Short-Term Energy Outlook," said Newell. "The new measure characterizes the degree of uncertainty in futures market prices, and provides perspective on the range of possible energy prices."

The agency calculates this uncertainty using "implied volatilities" derived from the New York Mercantile Exchange options markets to construct confidence intervals around the NYMEX crude oil futures prices. Implied volatility is synonymous with the standard deviation of expected returns, and is calculated from traded option prices
using the Black commodity option pricing model.

Based on this new calculation, the 95 percent confidence interval for the December 2009 futures contract ranges between $48 per barrel and $96 per barrel, a $48 per barrel difference. There is about a 5 percent chance prices will fall outside of the 95 percent confidence interval, the EIA says.

The outlook points out that while volatility in oil prices are lower and confidence intervals are narrower than last year, the current confidence intervals still indicate that there is much uncertainty in the outlook for oil prices.

"Energy Price Volatility and Forecast Uncertainty" can be found at: www.eia.doe.gov/emeu/steo/pub/special/pdf/2009_sp_05.pdf.

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