We have revealed long term sustainable
trends in the difference between producer price index for oil and the overall
PPI. In the long run, one can foresee the direction of oil price trend which is
crucial for investments. Moreover, there are many short-term price fluctuations
around the trend which have large amplitudes and thus allow active
speculations.

In the beginning of 2009, we developed a
model [1, 2] predicting the long-term price evolution for various subcategories
of consumer and producer price indices as well as major commodities: gold,
crude oil, metals, etc. The model was based on one prominent feature of the
difference between consumer (producer) prices of individual components and the
overall consumer (producer) price index. These differences are characterized by
the presence of sustainable long-term (quasi-) linear trends. For many producer
price indices, these trends are slightly nonlinear but still robust. They are
observed in subcategories with varying weights in the CPI and PPI: meats [3],
gold ores [4], durables and nondurables [5], jewelry and jewelry related
products [6], and motor fuel [7].

For major CPI and PPI subcategories,
these trends last from five to twenty years and then turn to trends with
opposite slopes. The transition to new trends lasted three years at most. We
have not revealed any clear turns after 2009 and the current transition period
might last longer. There are also several subcategories without slope changes since
the start of the relevant measurement as reported by the Bureau of Labor
Statistics [8]. All CPI and PPI time series (in this study we use seasonally
adjusted CPIs and not seasonally adjusted PPIs) were retrieved from the BLS. The
best example of such a one-leg trend since 1980 is the consumer price index of medical
care. The index of communication has been linearly deviating from the
headline CPI since 1998; before 1998 it had been reported as an
indistinguishable part of the index of education and communication.

In the short run, actual prices
oscillate around the long-term trends with varying amplitudes. In a sense, the
trends represent the lines of gravity centers for given prices and any large
deviation from the trends must be compensated promptly. As a result, both
short- and long-term predictions of commodity prices are feasible. In the long
run, the prices follow up the trends. In the short-run, the next move in a
given price depends on the current position relative to the corresponding
trend. When far from the trend, the
price is more likely to start returning. When approaching the trend, the price
may choose any direction for the further evolution, i.e. it should not
inevitably go the other side of the trend. In this article, we focus on crude
oil and motor fuel.

For the price index of motor fuel, we developed
a similar model as based on the deviation from the core CPI, i.e. the headline
CPI less food and energy. Using this
model, we predicted the evolution of oil price as well. The overall performance
of the model between March and December 2009 was reported in [9]. Here we also
revise the long-term prediction of crude petroleum and motor fuel price and make
necessary corrections to the model as related to the observations since March
2009.

The model derived in [1, 2] implies that
the difference between the overall CPI (same for the PPI),

*CPI (PPI)*, and a given individual price index iCPI (iPPI)*,*can be described by a linear time function over time intervals of several years:*CPI(t) – iCPI(t) = A + Bt*(1)

, where 100 in December 1997 when
the overall CPI was already at the level of 161.8 (base period 1982-84 =100).

*A*and*B*are the regression coefficients, and*t*is the elapsed time. Therefore, the “distance” between the CPI and the studied index is a linear function of time, with a positive or negative slope*B*. Free term*A*compensates the difference related to the start levels for a given year. For example, the index of communication was started from the level of
Figure 1 displays examples of linear
trends in the two differences related to the scope of this article. In the left
panel, the evolution of the index of motor fuel relative to the headline CPI is
shown. Notice that in the original paper [7] we referred the index of motor
fuel to the core CPI, but the discrepancy between the headline and core CPI is
negligible relative to the change in the index of motor fuel. There are two distinct periods of linear
dependence on time: from 1980 to 1999 and from 2001 to 2008. Apparently, there is
one finished transition period between 1999 and 2001, where the trend with a
positive slope (

*B*=+4.2) changed to a negative one (*B*=-21.1), in both cases the determination coefficient being very high: R^{2}~0.89. The first transition period is characterized by elevated price volatility. Since 2008, the negative trend in the difference has been suffering a transition to a positive one, which is shown in Figure 1 by a dashed line. This transition is characterized by a much higher volatility and has been fading away since the end of 2009. Without prejudice, we have drawn the new trend as increasing from -110 in 2009 to -60 in 2016. (Notice that we made a different tentative assumption in [10] since we had no actual data after 2009.) This defines the long-term prediction of the motor fuel index and fits observations since 2010.
In the right panel, the difference
between the PPI and the index of crude petroleum (domestic production) is shown
between 1985 and 2012. There are two distinct periods of linear dependence on
time: from 1988 to 1999 and from 2001 to 2008. The slopes of regression lines
in both periods are different from those for the index of motor fuel: +2.9 and
-17.9, respectively. There was one transition period between 1999 and 2001,
where the original positive trend was turned down. We expect the difference to
grow (the oil price index has to rise slower than the PPI) from -80 in 2009 to
+20 in 2016; the growth rate is ~14 point per year.

Figure
1. Illustration of linear trends.

*Left panel*: the difference between the headline CPI and the index of motor fuel between 1980 and 2012.*Right panel*: The difference between the overall PPI and the (producer price) index of crude petroleum (domestic production). In both panels: there are two quasi-linear segments with a turning period between 1998 and 2001. Since the end of 2008, both differences have been passing a transition. Linear trends with relevant linear regression lines and corresponding slopes are also shown.
From Figure 1, one can conclude that the
presence of linear trends is a basic feature of the CPI and PPI components
which is likely to be repeated in the future. Another fundamental characteristic
of the differences consists in the fact that all deviations from the trends
were only short-term ones. This implies that any current or future deviations
from the new trends in Figure 1, which have been under development since 2008,
must be compensated promptly. This feature allows short-term (months) price
predictions.

Simple visual inspection of the
transition period in Figure 2 shows that the difference in timing and amplitude
between motor fuel and crude oil is not too big. The amplitude of oil price fluctuations is
higher since 2007 and especially during 2011 and 2012. In turn, the fluctuations
in motor fuel price were slightly higher between 2000 and 2007.

Figure 2. Comparison of two differences.

Figure 3 presents both differences after
2007. Overall, the evolution of the difference between the CPI and the index of
motor fuel follows the new trend since 2011. One may expect that after a few months below
the trend (say, through October –December 2012) the next move will return the
difference above the trend, i.e. the price of motor fuel will fall a bit
relative to the CPI. In the long run motor fuel will be losing its pricing
power relative to the CPI. The oil price prediction for 2013 is similar. The difference in Figure 3 will reach the new (dashed)
trend line and the oil price has to fall below $80 per barrel.

Figure 3.

*Left panel*: The difference between the headline CPI and the index for motor fuel.*Right panel*: Evolution of the difference between the PPI and the index for crude petroleum (domestic production). Notice oscillations around the new trends.
The forces behind the observed long- and
short-term behavior are not accessible yet but very powerful. We may assume
that they are fundamental and affect the economy to its roots. These forces
retain equilibrium among all economic agents and originate the sustainable
trends in the differences between consumer (producer) price indices. At some
point, the forces meet their limits and should be re-balanced in order not to
harm the economy. As a result, the trends in the CPI and PPI turn.

Meanwhile, it is instructive to revise
our long-term prediction of oil price shown in Figure 1. After a few minor
adjustments to the initial and final levels of the PPI and the index of crude
petroleum, Figure 4 depicts the revised prediction after 2010. It is slightly different from our previous
prediction with oil price in 2016 set between $30 and $60 per barrel. Short-term
fluctuations cannot be predicted at a horizon of several years. However, the
larger is a given deviation from the trend the larger is the returning force.

Figure
4. The evolution of crude oil price. Open circles represent the evolution of
(monthly average) oil price for the period between 2001 and 2012. Dashed lines – the upper and lower limits of
the new trend between 2009 and 2016. According to the prediction, the price
should fall to the level between $60 and $30 per barrel by 2017.

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