Commodity-price forecasting—or any type of forecasting, for that matter—is a slippery slope. Many forecasts turn out to not be worth the power-point slides they’re printed on, to the chagrin of E&Ps and investors alike. Still, they are that necessary evil.

Recently, Helen El Mallakh, associate director of the International Research Center for Energy and Economic Development (ICEED), Boulder, Colorado, highlighted the pitfalls of energy forecasting in a presentation hosted by the Independent Petroleum Association of Mountain States in Denver.

Why do so many forecasts miss the mark? Forecasters with finance, rather than industry, backgrounds may be less accurate, and over-reliance on technical analysis rather than fundamental factors can also wreak havoc. According to El Mallakh, national energy companies and some small-to-mid-sized E&Ps have proven more likely to get it right. She credits their reliance on fundamental factors, their producer backgrounds, and their smaller price ranges.

Given that there will always be myriad forecasts floating about, and many will not prove accurate, how can the creditable forecasts be separated from the chaff?

“We tend to discount our own understanding of market prices and fundamentals, oftentimes listening to those with less experience and agendas who are supplying the forecasts,” says El Mallakh.

“Even though we do have a pretty good idea of what prices will be, external and internal factors tend to make us revise our own estimates.”

Avoid these three pitfalls when evaluating forecasts, El Mallakh advises. First is the Kool-Aid Syndrome, which selects particular forecasts to support an internal bias within a company. Here, only forecasts that support the underlying business objectives of the leadership are used. For energy companies, mistakes are often due to flawed forecasts of commodity pricing, supply and demand; regulatory and governmental policy; and actions of other players/stake­holders.

The solution to internal bias is to use a diversity of price forecasts, and spend some time with those who are drinking different Kool-Aid.

A second error is using forecasts with built-in external biases—this she terms the Enron Syndrome. Bias types involve both financial and ideological agendas; questionable economics and technical analysis; market instruments used as indicators of future spot prices; and timing and direction.

These technical analyses often contradict each other. They may depend upon the time series used (better for short-term trading), and are abused in “red light, yellow light, green light” software systems, she says. And, they are not based on fundamentals of the underlying commodity.

Avoid external bias by, again, seeking a diversity of sources, understanding bias, and saying no to forecasts you can’t understand or that lack fundamentals, El Mallakh advises.

And last, be wary of Information Overload Syndrome. Media often bombard the audience with information that is non-value adding, and extreme, she says. Fear-based information can lead to a focus on things that cannot be controlled or changed.

She also warns that forward contracts are not necessarily the best proxy to use as a forecast of future spot prices. Many forecasters embed forward pricing, which tends to be biased to the upside based on buyers’ premiums.

The safest way to shelter from inaccurate forecasts is to stay in the middle of the pack, following the consensus, she says. “The energy industry as a whole follows this model. There’s no strategic advantage with being part of the ‘rookery,’ but it’s safe and can be relatively low cost.”

The energy industry has a good idea of where prices are going directionally, she said.