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Uncertainty - Expectations and Fundamentals: Whatever Happened to Long-Term Oil Prices? / Bassam Fattouh &#38; Pasquale Scaramozzino, Oxford : OIES, March 2011, 7 p. (Oxford energy comment)http://www.oxfordenergy.org/pdfs/comment_15_03_11.pdf One  of the major features of the oil market during the 1990s was the  relative stability of the long-term oil price. While the spot price and  the price of near-term futures contracts sometimes exhibited sharp price  volatility that volatility was only partially transmitted to the back  end of the futures curve which was anchored around the $20-22/barrel  range. However as oil prices rose sharply during the boom years the  consensus on the oil price that would balance the long term fundamentals  of the oil market broke down and the whole futures curve became subject  to a series of shifts. Our empirical evidence suggests that in the late  1990s and early 2000s there was limited evidence of adjustment between  short-term and long-term oil prices. These dynamics however changed in  early 2005 with the long term price making most of the adjustment  towards the prompt price. We suggest an interpretation of the long-term  behaviour of oil prices based on the insights of two models. The first  is based on a signal extraction mechanism and shows that when the  private beliefs by investors about the long-run determinants of oil  prices become less precise relative to the information contained in the  current spot price then the expected future oil price becomes closer to  the current spot price. The second model is based on Bayesian updating  and shows that if the variability of the spot price increases and/or if  the spot price remains higher over a sustained period of time than  anticipated by investors then the probability distribution of the  parameter capturing the speed of mean reversion will shift and the  expected future price will move closer to the current spot price. Our  analysis predicts that in the face of increased uncertainty the  long-term and short-term prices are bound to exhibit similar movements.  These changes had important consequences on the oil price formation  process. (© OIES)