"The words of the prophets are base and full of lies....
naked intelligence and good advice are the best prophet."
A character in the play "Helen" by Euripides (480 - 406 BC)
"Scenario planning is a specialized strategic thinking activity that develops alternative futures and examines their impact on the enterprise. It is a creative process of visualizing how the world might look tomorrow and identifying the signposts which will indicate which of these future scenarios is evolving.
Scenario planning is most useful in evaluating the risk associated with a major decision by examining possible decision outcomes under a variety of future scenarios".
Peter Schwartz, 1984. As most futurists will think about the next 10 or 20 years, the boldest I have seen is George Freeman's (2010) with "The next 100 years, A forecast for the 21st Century". I would object to the use of the term "forecast" in the title.... One could say that just because of disappointing results with forecasts for the middle ansd long term, scenarios have been introduced.
Scenarios were introduced by Pierre Wack (1922 - 1999) in Royal Dutch Shell's Planning Division in London in the 1970ies. In the mid-eighties I was fortunate to spend four years in this "think-tank". Then I met well-known scenario planners, such as Pierre Wack and I worked for Peter Schwartz (See Hawken et al., 1977), who was the teamleader of the scenario section. As scenario cycles took two years, I experienced the process twice during that period.
Why would we use scenarios in the petroleum industry? When we look at the amazing changes that have affected the world petroleum scene in recent history, it is obvious that simple short term forecasting is most unreliable, and insufficient for long term decision making. Most oil fields have an active life of many decades. So it becomes logical to describe the future for, say, twenty years. We could in desperation say, as Einstein did: "I do not worry about the future. It comes soon enough". But it should be possible to attempt to survey possible futures, without attaching probabilities to each. Describing the future is difficult to do with one single story. We undoubtedly need several alternative descriptions of plausible futures if we wish to capture the future risks and opportunities. One important aspect of scenarios is that they have to be "internally consistent stories". The consequence is that scenarios do not produce forecasts as might be possible for well defined domains in the short term, but tools for long term decision-making. Therefore it is useful to realize the differences between scenarios and forecasts:
For the oil industry scenarios can be useful to explore the possible future of oil prices. Such scenarios might be called "Focussed Scenarios". In the 1960ies an oil price change of a few cents/barrel was news. If anybody then would come with a scenario that includes oil prices up to $150/b, he would be sent to an asylum. Unfortunately, reality is often far beyond our imagination. Building scenarios helps to outline the plausible limits to oil prices, so that the ensuing risks and opportunities are covered. Although the world is quite chaotic, there are always "fundamentals" that constrain our wildest imaginations. An example of a fundamental is population growth, another is the car fleet. Sudden changes are quite impossible.
Another mechanism in this chaotic world is feedback. There are positive and negative feedback mechanisms at work in the economy. Studying those helps also to constrain the possible futures. System Dynamics is used, not to make a computer model of the real world, but to understand the interacting mechanisms. For oil prices one could picture the feedbacks as in the following picture:
In this feedback model we start at the center, the trading rooms where the spot price is determined by the supply/demand curves. This spot price machine is constantly changing and it is not always a simple market mechanism. However, it most often determines the energy prices, as those are contractually, or by competition related to the oil price. Energy prices affect the economy. There is a negative feedback that make people use less energy, i.e. less energy demand, hence also less oil demand. From there again to the spot market. Influences on the right tend to modify, or inhibit free market mechanisms: Governments in producing and consuming countries, as well as the all-important OPEC cartel. It would seem that OPEC can always dictate the oil price, reality shows a different picture. The growth of production in the non-OPEC countries has limited the power of OPEC to at least a certain extent.
It is also important to note that there are "delay mechanisms". Oil price changes take a little time to work through. The stocks of oil affect the speed of price changes to the consumer. For gas, if still coupled to oil price, there is in many places a 6 months delay spelled out in contracts, the gas price calculated on the bases of oil-product prices of six months earlier. A fairly important delay mechanism is the effect of higher oil prices on the world oil production. It takes 2 to 3 years before price rises work through in production.
Technological disruptions can have a rather sudden effect on the oil price. An example is the oil production in the USA from fractured source rocks and tight reservoirs, where improvements in fracking techniques have allowed commercial oil and gas production. A boom followed, which was not appreciated by the OPEC oil producers. Although they were partly successful in sabotaging this new source of oil by raising their production to force a lower oil price, it has not completely succeeded. The oil-shale boom changed the USA from an oil-importing country into an oil-exporting country. For a gas a similar change took place.
Another example of technological disruption is the development of electric cars. And not only these replacing gas-driven vehicles, but also the advent of cars that drive automatically, even without a steering wheel. If it will be possible to change the road transport system of today into a "Transport as a service" electricity-driven system, this would be a major disruption as the business as usual model for the oil industry (see RethinkX).
The above oil model was valid in the 80ies of the last century, but "energy" is becoming more gas-oriented, because of more gas discoveries than oil, and the importance of the LNG spot market. Also "Governement influence" is not only meaning that govt's want the maximum benefits from their resources, but also driven by climate concerns.
Peter Schwartz has summarized the important steps in the scenario process as follows:
To summarize: oil price scenarios go beyond a probabilistic evaluation of an opportunity. They are alternatives to consider in the evaluation process. They may help in avoiding unpleasant surprises and prepare us for grasping new opportunities if they arise.
A few examples of scenarios: Shell scenarios, many since 1970, Hawken, et al., 1982 with general scenarios, Nederlof (1992) with a focussed gas scenario and a rather daring scenario by George Friedman (2010), "The next 100 years".