United States Government Accountability Office

Washington, DC 20548 

April 26, 2007 

The Honorable Carl Levin 

Chairman 

The Honorable John McCain 

Ranking Member 

Committee on Armed Services 

United States Senate 

The Honorable Ike Skelton 

Chairman 

The Honorable Duncan L. Hunter

Ranking Member 

Committee on Armed Services 

House of Representatives 

Subject: Defense Budget: Review of DOD’s Report on Budgeting for Fuel Cost 

Fluctuations

The Office of Management and Budget (OMB) establishes for the Department of 

Defense (DOD) the price DOD will use for pricing crude oil when constructing its 

budget for upcoming fiscal years. DOD in turn uses OMB’s price in establishing the 

standard price to be used for a barrel of fuel for budgeting purposes by DOD fuel

customers such as the military services. Because of the volatility of world petroleum 

prices, the standard price for a barrel of fuel included in the President’s annual 

budget request for DOD may be lower or higher than the actual price established by 

the world market at any point in time after DOD’s budget request is submitted to the 

Congress. During the fiscal year, DOD pays for fuel at the actual market rate, which 

typically varies from the budgeted rate. As a result, if the actual price of crude oil 

increases above the price DOD charges its customers, more dollars are needed to pay 

for fuel than originally budgeted. If the actual price is lower than what DOD charges 

its customers, DOD has more dollars than needed. Additionally, if DOD responds to 

increases in the world market crude oil prices by increasing the price it charges its 

customers above what they initially budgeted, the customers will have additional 

funding needs to pay their fuel bills. 

Concerned as to whether DOD’s method for setting fuel prices has produced realistic 

budget estimates, last year the Congress required DOD to consider alternative 

methods. Specifically, the John Warner National Defense Authorization Act for Fiscal 

Year 2007 requires the Secretary of Defense to submit a report on the fuel rate and 

GAO-07-688R Fuel Fluctuations 
cost projection used in the annual DOD budget presentation.1

 The act required that 

DOD identify alternative approaches, including approaches used by other federal 

departments and agencies and the feasibility of using private economic forecasting 

organizations, for selecting fuel rates that would produce more realistic estimates of 

the amounts required for DOD to accommodate fuel rate fluctuations. DOD is also 

required to discuss the advantages and disadvantages of each approach and to 

identify the department’s preferred approach among the alternatives and provide a 

rationale for preferring that approach. Finally, the act further requires that GAO 

review DOD’s report, including the basis for the Secretary’s conclusions for the 

preferred approach. DOD submitted its report to the Congress on February 27, 2007. 

In response to the act, we determined (1) the extent to which DOD identified and 

evaluated alternative crude oil forecasts that could be used in setting its fuel rates—

such as forecasts used by other federal departments and agencies and private 

economic forecasting organizations, and (2) DOD’s basis for selecting its preferred 

fuel rate setting approach. 

In conducting our work, we examined DOD’s report to the Congress on budgeting for 

fuel cost fluctuations and other pertinent documentation on DOD’s methodology to 

identify the alternative crude oil forecasts DOD considered for selecting budgeted 

fuel rates. We interviewed responsible officials from the Office of the Under 

Secretary of Defense, the DOD Comptroller, and Defense Logistics Agency (DLA), 

and OMB to discuss DOD’s methodology and rationale for selecting its preferred fuel 

rate selection approach. We also assessed DOD’s comparative analyses and the basis 

for its conclusions. We conducted our work from February 2007 to April 2007 in 

accordance with generally accepted government auditing standards. 

Summary 

DOD identified and evaluated approaches for forecasting crude oil prices used by 

other federal departments and forecasts from private forecasting organizations. DOD 

received responses from eight agencies.2

 DOD determined that seven of the eight 

respondents used DOD’s forecast, did not have a forecast method, or did not have a 

forecasting method that would accommodate the size and complexity of DOD’s fuel 

requirement. Thus, DOD concluded that only the Department of Energy’s (DOE) 

forecasting method, which uses the Energy Information Administration (EIA)3

 to 

provide forecast prices for crude oil, was an option that warranted further evaluation. 

According to DOD’s report, it conducted four4

 analyses using different scenarios to 

compare its forecast approach, which is based on crude oil forecasts provided by 

 1

Pub. L. No. 109-364, § 1006 (2006). 2

DOD solicited inquiries from at least 21 federal departments and several independent agencies but did

not have information on the exact number. 3

The Congress created EIA within the DOE in 1977. As a statistical agency, it provides policyindependent data, forecasts, and analyses to promote sound policy making, efficient markets, and 

public understanding regarding energy and its interaction with the economy and the environment. 4

DOD actually analyzed five scenarios but eliminated one in its report to the Congress because the data were 

similar to scenario four.

Page 2 GAO-07-688R Fuel Fluctuations 
OMB with the methods used by DOE and 38 private forecasting organizations. DOD 

reported that DOE’s EIA analysis produced forecasts that were marginally closer to 

actual crude oil prices than either DOD’s current method or most other private 

organizations’ forecasts, and only in a few cases did the private organizations 

produce forecasts that were closer to actual costs than DOD’s current method. DOD 

selected its current method as its preferred forecasting approach over the DOE and 

38 private forecasting alternatives. According to the DOD report, DOD chose to

continue to use its current rate setting method because it believes none of the 

alternative forecasting methods produced significantly more accurate results. 

Specifically, DOD did not believe that the margin of difference between forecasts 

based on its current method and alternative approaches was significant enough to 

warrant a change. 

In assessing DOD’s comparative analysis, we found limitations on the scope of the 

analysis due to the lack of available historical forecast data. Specifically, DOD 

included 18 months of data or less in each of the comparative scenarios it analyzed 

and the scenarios did not involve forecasts from the same time period DOD used to 

set its budget request. According to DOD officials, historical forecasting data were 

not available to conduct a more extensive multiyear comparison or to replicate the 

time-frame in which the fiscal year 2006 budgeted bulk fuel rate was set. DOD 

officials agreed that had it been available, these additional data would have produced 

a more ideal comparison. Consequently, based on the results of the analysis that 

DOD was able to conduct with the data available and given the volatile crude oil 

market, we agree that the results did not provide a compelling reason for DOD to 

adjust its rate setting approach and that DOD’s current forecast based on OMB’s 

guidance for crude oil prices is a reasonable approach. In order for DOD to conduct 

a more robust and extensive analysis, it would need to begin capturing and 

maintaining the necessary forecast data now to conduct such analyses in the future. 

Background 

DOD is the largest federal consumer of energy, accounting for over 92 percent of the 

petroleum-based energy consumed by the federal government. DOD bulk fuel pricing 

is based on OMB’s guidance for crude oil prices. DOD uses three components in 

establishing its budgeted bulk fuel price. The first component is the price for crude 

oil, the second component is the added expense for refining the crude oil, and the 

third component is a factor to account for DOD’s overhead costs associated with 

transportation and storage of the fuel. To estimate the cost of crude oil, the Council 

of Economic Advisors, the Department of the Treasury, and OMB, referred to as the 

Troika, jointly prepare a set of economic assumptions for agencies to use in 

preparing their overall budgets. From these economic assumptions, OMB directly 

provides DOD the crude oil price projections it uses in setting its bulk fuel price. In 

developing the crude oil price projections, the Troika uses oil price projections 

coming from the prices in the futures market for West Texas Intermediate crude oil in 

the New York Mercantile Exchange. For the 2007 budget, futures prices projected 5 

years ahead were used in developing crude oil price projections. DOD and its 

customers use refined oil products, such as jet fuel and diesel fuel, and as such DOD 

Page 3 GAO-07-688R Fuel Fluctuations
has to include in its bulk fuel budget prices the additional cost of refining the fuel 

above crude oil projections. This component is estimated using a statistical 

technique that analyzes the historical data relationship between crude oil prices and 

refined oil prices.5

 Finally, DOD adds an overhead factor that reflects transportation 

and storage costs of the petroleum products to DOD. When comparing DOD’s 

current method for setting bulk fuel prices to alternative methods, the refining crude 

oil expense and overhead factor should not be considered. Specifically, DOD’s

refining crude oil expense and overhead costs have to be added to any forecast DOD 

used to set fuel prices, and are unique factors to DOD. Consequently, DOD’s cost for 

crude oil (the first component) is what is comparable to other forecasts for oil. 

DOD Identified and Evaluated Alternative Crude Oil Forecasts 

In meeting its legislative requirement, DOD identified and evaluated alternative crude 

oil forecasts by other federal departments and forecasts from 38 private forecasting 

organizations. DOD evaluated these different forecasts by conducting a comparative 

analysis of four different scenarios, in which DOD reported that only one method 

produced slightly better estimates than its current method. However, DOD believed 

that the improvement was marginal and, along with the limited scope of its analysis 

due to the data limitations, did not warrant a change from DOD’s current 

methodology. 

 

DOD Evaluated Federal Agencies’ and Private Organizations’ Crude Oil Forecasts 

In its report, DOD evaluated crude oil forecasts used by other federal departments 

and agencies. DOD solicited information from several federal departments and 

agencies as to what method they used to forecast crude oil. DOD received responses 

from eight departments and agencies: the Departments of Commerce, Energy, 

Justice, and State, the U.S. Postal Service, U.S. Customs and Border Protection 

agency, General Services Administration, and Federal Bureau of Investigation. Of the 

eight respondents, DOD evaluated each approach and determined seven did not have 

a forecast method that would meet its needs. Of these seven, one agency used DOD’s 

forecasts, another did not have a forecast method in place and the remaining five did 

not have crude oil forecast methods that DOD believed would accommodate the size 

and complexity of DOD’s fuel requirement. Consequently, DOD concluded that only 

one agency—DOE, which uses EIA forecasts—had a forecast that warranted further 

evaluation. 

In addition to evaluating the methods used by other departments and agencies to 

forecast crude oil prices, DOD conducted research to determine which private 

organizations had experience in forecasting energy-related commodities. DOD 

determined that 38 private organizations had forecasts for crude oil prices that could 

be included in its comparative analysis. 

 

 5

The statistical approach used for the 2007 budget and earlier budgets was regression analysis. A DOD energy 

official indicated that they are examining different statistical methods to look at this relationship in the future. 

Page 4 GAO-07-688R Fuel Fluctuations 
DOD’s Report Included a Comparative Analysis of Four Scenarios to Evaluate Crude 

Oil Forecasts 

To evaluate the different crude oil forecast, DOD’s report included a comparative 

analysis of four different scenarios. DOD compared its OMB-based forecast, DOE’s 

EIA forecast, and up to 386

 other private economic forecasting organizations’ crude 

oil forecasts to EIA actual price data to determine which method came closest to 

predicting actual crude oil prices. DOD’s report included four different comparison 

scenarios that compared June 2005 forecasts to actual rates for (1) the average price 

for the first quarter of fiscal year 2006, (2) the average price for the third quarter of 

fiscal year 2006, (3) the average price for the entire 2006 calendar year, and (4) each 

of the six quarters from the fourth quarter of fiscal year 2005 to the first quarter of 

fiscal year 2007. The results of these four scenarios follow. 

The first scenario compared OMB’s, EIA’s, and 38 private organizations’ June 2005 

forecasts to EIA’s actual crude oil price of $60.00 per barrel for the first quarter of 

fiscal year 2006. Table 1 shows that 1 private organization’s forecast and the EIA 

forecast performed better—were closer to the actual price—than the OMB forecast 

for this time period, and 37 of the 38 private organizations had forecasts that 

performed below—were farther away from the actual price— than OMB’s forecasts. 

 6

According to DOD officials, they were not able to obtain forecasts for each of the 38 private

organizations for each scenario DOD evaluated because the historic forecasting data were not always

available. Therefore, the number of private organizations compared in each scenario varies. 

Page 5 GAO-07-688R Fuel Fluctuations
Table 1: Comparison of Forecasts from OMB, EIA, and 38 Private Organizations in June 2005 to the EIA 

Actual Price Using the Average of the First Quarter of Fiscal Year 2006 

Dollars per barrel 

Organization June 2005 forecasts 

Difference between June 2005 forecast 

and actual price of $60.00 

Private organization 

A forecast 57.10 (2.90) 

EIA forecast 55.00 (5.00) 

OMB forecast 53.43 (6.57) 

37 other private 

organizations’ 

forecasts Ranging from 32.00 to 53.00 (28.00 to 7.00)

Source: DOD data. 

The second scenario compared OMB’s, EIA’s, and 28 private organizations’ June 2005 

forecasts to EIA’s actual price of $70.41 per barrel for the third quarter of fiscal year 

2006. Table 2 shows that 3 private organizations’ and the EIA forecast performed 

better than the OMB forecast for this time period and 25 of the 28 private 

organizations had forecasts that performed below OMB’s forecasts. 

Table 2: Comparison of Forecasts from OMB, EIA, and 28 Private Organizations in June 2005 to the EIA 

Actual Price Using the Average of the Third Quarter of Fiscal Year 2006 

Dollars per barrel 

Organization June 2005 forecasts 

Difference between June 2005 forecast 

and actual price of $70.41 

Private organization 

A forecast 59.30 

(11.11) 

Private organization 

B forecast 55.00 

(15.41) 

Private organization 

C forecast 54.00 

(16.41) 

EIA forecast 53.58 (16.83) 

OMB forecast 52.80 (17.61) 

25 other private 

organizations’ 

forecasts Ranging from 37.00 to 52.80 (33.41 to 20.41)

Source: DOD data. 

The third scenario compared OMB’s, EIA’s, and 13 private organizations’ June 2005 

forecasts to EIA’s actual price of $66.02 per barrel for calendar year 2006. Table 3 

shows that 1 private organization’s forecast and the EIA forecast performed better 

than the OMB forecast for this time period and 12 of the 13 organizations had 

forecasts that performed below OMB’s forecasts. 

Page 6 GAO-07-688R Fuel Fluctuations 
Table 3: Comparison of Forecasts from OMB, EIA, and 13 Private Organizations in June 2005 to the EIA 

Actual Prices for Calendar Year 2006 

Dollars per barrel 

Organization June 2005 forecasts 

Difference between June 2005 forecast 

and actual price of $66.02 

Private organization 

C forecast 55.00 (11.02) 

EIA forecast 54.23 (11.79) 

OMB forecast 52.58 (13.44) 

12 other private 

organizations’ 

forecasts Ranging from 41.80 to 51.25 (24.22 to 14.77)

Source: DOD data. 

The fourth scenario compared forecasts of OMB, EIA, and 1 private organization 

from the fourth quarter of fiscal year 2005 to the first quarter of 2007 to EIA actual 

prices for each of those quarters. As shown in table 4, the EIA forecast performed 

better than the OMB forecast for this time period, and the private organization’s 

forecasts performed below both OMB’s forecasts and EIA’s forecasts. 

Table 4: Comparison of Forecasts from OMB, EIA and 1 Private Organization to the EIA Actual Prices for 

the Fourth Quarter of Fiscal Year 2005 to the First Quarter of 2007 

Dollars per barrel 

EIA actual price EIA forecast OMB forecast Private organization 

D forecast 

4th Quarter 2005 63.19 52.83 52.68 52.50 

1st Quarter 2006 60.00 55.00 53.43 53.00 

2nd Quarter 2006 63.27 54.00 53.24 52.00 

3rd Quarter 2006 70.41 53.58 52.80 50.00 

4th Quarter 2006 70.42 54.33 52.37 49.00 

1st Quarter 2007 59.98 55.00 51.76 48.00 

Source: DOD data. 

The overall results of DOD’s four comparative analyses show that EIA forecasts 

produced forecasts that were closer to the actual price than OMB’s forecasts in each 

scenario7

 and 3 of the 38 private organizations outperformed OMB and EIA forecasts 

in individual comparison scenarios; however, no private organization consistently 

outperformed either OMB or EIA in all scenarios. 

DOD Selected Its Preferred Approach Based on Results of Its Comparative 

Analysis 

DOD selected its current method—based on OMB’s forecasts—as its preferred bulk 

fuel rate setting approach because it concluded that it’s comparative analysis showed 

that results using OMB’s forecasts were comparable to or better than the alternative 

forecasts it evaluated. Based on the comparative analysis performed, DOD concluded 

that because the results showed only marginal improvement (1.92 percent difference) 

 7

 The eliminated scenario compared the average price for the entire 2006 fiscal year for OMB’s, EIA’s and 1 private 

organization’s forecasts. This comparison also showed that EIA’s June 2005 forecast was more accurate than 

OMB’s forecast by 1.92 percent. 

Page 7 GAO-07-688R Fuel Fluctuations
in using EIA’s forecast over OMB’s forecast and since no private organization 

consistently outperformed OMB forecasts in all scenarios, it did not warrant a change 

from DOD’s current methodology. DOD also reported that inaccurate forecasts are 

pervasive in the current economic conditions based on market volatility. Thus, DOD 

concluded that changing forecasting sources or methods may not provide more 

realistic estimates for DOD at this time. 

Our Assessment Showed Data Limitations Constrained DOD’s Comparative 

Analysis, but Current Fuel Rate Setting Approach Seems Reasonable 

In assessing DOD’s comparative analysis, we found that lack of available historical 

forecast data limited the scope of DOD’s analysis. DOD included 18 months or less of 

data in each of the comparative scenarios it conducted. An economist in DOD’s 

Defense Energy Support Center, who performed the analysis, agreed that a thorough 

evaluation of a group’s long-term forecasting performance should include several 

different time periods. However, according to DOD officials, DOD was not able to 

obtain historical forecasting data to perform comparisons prior to June 2005 because 

these data are not retained by private forecast organizations. Consequently, DOD 

used June 2005 forecasts to predict crude oil prices for the various fiscal year 2006 

scenarios. However, DOD set its fiscal year 2006 budgeted fuel prices in December 

2004, 6 months earlier than the forecasts DOD used in the analyses. When DOD set 

its fuel rate in December 2004, the forecast it used predicted fuel costs 10 to 21 

months into the future (December 2004 to October 2005 through September 2006). 

Most of the scenarios DOD included in its analysis did not predict far enough into the 

future to replicate what DOD does each year when its sets its budgeted fuel rates— 

for example, scenario one only predicted 3 months into the future. In addition, 

OMB’s December 2004 forecast for crude oil was $40.45 a barrel, which was $12.98 a 

barrel lower than the June 2005 OMB forecast DOD used in scenario one. The closer 

the forecast is to the actual time-frame being estimated, the easier it is to predict a 

more accurate forecast. The DOD economist we spoke with agreed that it would 

have been a more meaningful analysis to use December 2004 forecasts, but again 

stated that forecasts were not available from EIA or private forecasting organizations 

for that time-frame. In fact, the EIA forecast data that DOD used in the analysis are 

only available from the month starting the forecast to the end of the next calendar 

year. For example, in December 2004, EIA forecasted data only through December 

2005—which would have been insufficient to provide a basis for DOD in establishing 

fiscal year 2006 rates. According to DOD officials, the timing of the EIA forecast data 

does not match up to the time-frame when DOD has to set its rates for budgeting 

purposes. 

Consequently, based on the results of the analysis that DOD was able to conduct with 

the data available, we agree that the results did not provide a compelling reason for 

DOD to adjust its rate setting approach at this time. Because of DOD’s decision to 

retain its current approach, we reviewed the basis for OMB’s forecast to determine if 

it is based on reasonable assumptions. OMB’s forecast is based on the futures market 

of crude oil. Using futures’ prices for crude oil seems like a reasonable approach 

because buyers and sellers are actually making purchases and sales based on their 

Page 8 GAO-07-688R Fuel Fluctuations 
ideas and information about the future price of crude oil. The futures price for crude 

oil for a particular date would reflect the interaction between buyers and sellers and 

the best estimate for the price of crude oil at that time. Barring more extensive 

analysis that might provide additional information to consider in selecting an 

alternative forecast, we believe that DOD’s current method for producing fuel rates is 

a reasonable approach. In order for DOD to conduct a more robust analysis, it would 

need to begin capturing and maintaining the necessary forecast data now to conduct 

such analysis in the future. 

Agency Comments 

DOD officials reviewed a draft of this report and had no comments. 

_ _ _ _ _ 

We are sending copies of this report to the Senate and House Armed Services 

Committees. We also will make copies available to others upon request. In addition, 

this report will be available at no charge on GAO’s Web site at http://www.gao.gov. 

If you have any questions concerning this report, please contact me at (202) 512-9619 

or pickups@gao.gov. Contact points for our Offices of Congressional Relations and 

Public Affairs may be found on the last page of this report. Key contributors to this 

assignment were Bonita P. Anderson, Renee S. Brown, Laura L. Durland, Julia Matta, 

Charles W. Perdue, and Jeanett H. Reid. 

Sharon Pickup 

Director, Defense Capabilities and Management 

(350960) 

Page 9 GAO-07-688R Fuel Fluctuations
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