Economic forecasts are a funny thing. If they attempt to project anything beyond the short-run (one year), be very skeptical. But short-run forecasts are not iron-clad either. I have a great time on this site making fun of economists and their predictions. Guessing what the intricate convergence of millions, if not billions, of different economic agents and their decisions will be, is kind of an exercise in futility. So if I were to predict what crude oil will do in 2010, I’d give you some markers to help you make your own decision long before I took a specific barrel price and defended the position.

I don’t have to; that’s what the likes of Merrill Lynch, Goldman Sachs, Barclays and Deutsche Bank are for. Oh by the way, the Congressional Budget Office (CBO) projects the U.S. government will make $7 billion from the TARP bank bailouts. Unfortunately, the CBO also estimates the total cost of TARP will be $99 billion, due to money loaned to AIG, GM and Chrysler that will not be recovered. Taxpayers really had to ante up to keep the banks breathing but at least the merging conglomeration of banks we subsidized can make forecasts for our viewing pleasure.

Merrill feels as though crude will be pushed up to $92/barrel in 2010, possibly pushing the century mark. The guess is supported by the belief that global economic growth will be 4.4% in 2010 and interest rates will remain low. Goldman Sachs and Barclays share similar feelings. (1)

Deutsche Bank says the economy won’t be quite so rosy. They have global economic growth pegged at 3.2%, and a concern that rising interest rates will support a stronger dollar. (1) Because oil transactions are denominated in dollars, the more the US dollar is worth, the fewer dollars it takes to purchase the same amount of oil. Thus, a strong dollar lowers the price of crude oil, all else equal. I have made the case on this website that crude oil spiked to over $140/barrel 18 months ago, during a recession, because the Federal Reserve dumped unprecedented money into the economy. The precipitous rise in the money supply to lower interest rates also devalued the dollar. Therefore, it took more dollars to purchase the same amount of oil. A lot more dollars.

It shouldn’t be overlooked that crude oil is a fixed marketplace (as in “the fix is in”), with the oil cartel OPEC able to control levels of supply to manipulate prices to their liking. Speculators play a role in oil prices, although I believe it is a short-run role, and not nearly as significant as supply and demand.

Banks have different views of what interest rates will do in the coming year. Because interest rates affect the value of the dollar, which affect the number of dollars necessary to purchase a given amount of crude oil, interest rates are a key marker to keep your eye on.

The Federal Reserve said in mid-December that economic conditions are “likely to warrant exceptionally low levels of the federal funds rate for an extended period.” Bernanke and company have not said anything since to change the outlook on interest rates. Currently the federal funds rate is between 0-0.25%. The deficit keeps ballooning as well, another negative for the dollar. One of the many examples of this is a recent Congressional Budget Office (CBO) estimate that the stimulus bill will cost an additional $75 billion more than expected, from $787 billion to $862 billion. (2) (5)

I would anticipate interest rates to remain near zero for the lion’s share of 2010, if not beyond. After all, the national unemployment rate was still 10% in December, and underemployment was pegged at 17.3% in the same month. (3) (4) With oil hovering around $80/barrel today, any pickup in economic growth across the globe should push prices upward some. I also don’t see OPEC going the entire year offering levels of supply that minimize profits. And, if speculators buy into the global economic growth story offered by Merrill and company, we may see a short-run bump from futures trading.

In conclusion, keep an eye on interest rates, because interest rates affect the value of the dollar. Interest rates and crude oil tend to be negatively correlated. Other factors that hurt the dollar include fiscal and monetary policy. If the U.S. continues to run up major deficits, the dollar will take a hit. Also, look at the supply levels OPEC plans to bring to market. And lastly, if global economic growth expands in 2010, so, too, will demand for energy.

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(1) Clueless about oil prices – CNNMoney.com, retrieved January 26, 2010, http://money.cnn.com/2010/01/26/news/economy/oil_prices/index.htm

(2) New York Federal Reserve – newyorkfed.org, retrieved January 26, 2010, http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm

(3) Bureau of Labor Statistics – BLS.gov, retrieved January 26, 2010, http://www.bls.gov/CPS/

(4) Bureau of Labor Statistics – BLS.gov, retrieved January 26, 2010, http://www.bls.gov/news.release/empsit.t12.htm

(5) Stimulus is now $75 billion more expensive – CNNMoney.com, retrieved January 26, 2010, http://money.cnn.com/2010/01/26/news/economy/stimulus_cbo/index.htm