Does a U.S. recession mean lower oil prices? Not necessarily
By Jad Mouawad
Wednesday, January 23, 2008
NEW YORK: As fears of a U.S. recession ripple across the globe this week, analysts and energy experts are wondering whether the great oil boom of the past five years is finally coming to an end - or whether it is merely taking a break.
While an economic slowdown might lead to lower oil demand, as consumers scale back their gasoline consumption and businesses cut down on air travel, economists say this might not necessarily lead to much lower energy prices.
Oil supplies are tight, geopolitical tensions remain high, and oil companies still need higher prices to bring badly needed and more costly oil to the market.
After briefly touching $100-a-barrel twice this year, oil prices have shed over 12 percent in a few days. Crude oil for March delivery on the New York Mercantile Exchange was down $2.44, or 2.7 percent, at $86.77 a barrel in late trading Wednesday.
Despite the ominous clouds hanging over the economy, and the recent stock market losses, energy analysts say they believe oil prices will average $80 a barrel this year, $8 a barrel higher than last year's average - and nearly double that of 2004. Even as the economic growth slows, the world might still find itself confronted with high energy costs, a situation that bears uncomfortable parallels to the mid-1970s or the early 1990s.
The prospect of an oil-price collapse, like the one that followed the Asian financial crisis in the late 1990s, is a remote one in the minds of energy investors who bet on historically high prices. The crude oil futures contract for delivery in two years currently trades at around $83 a barrel.
"The rally of the past few years seems like it is coming to an end," said Antoine Halff, the head of commodities research at Newedge, a brokerage firm. "But does it mean we're reverting to the lows we had previously, I don't think so. There are other factors that are providing a floor to prices."
Oil production is constrained by shortages in materials and labor, cost increases and widespread delays. Meanwhile, geopolitical tensions in Iraq, Iran, and Nigeria, and tougher political stances by Russia and Venezuela, have hampered production growth from some of the world's most promising suppliers.
"I don't think we will have a day of reckoning for oil prices because I don't think we have a bubble," Halff said. "This is more like an easing of the upward trend."
For analysts at Barclays Capital in London, "The ongoing deterioration in the economic environment is taking its toll on prices, but with constraints on the supply-side giving no sign of easing, the scope for downside is limited in our view."
The concern now among economists and policy makers is that high energy prices could weigh more heavily now that economies are confronted with the prospect of lower growth. On a visit to Cairo on Wednesday, Samuel Bodman, the U.S. energy secretary, told reporters that high prices were starting to affect the American economy.
"The economy has been able to withstand it until now," Bodman said. "I believe the $100 price of oil is starting to have an impact."
Energy analysts point to a series of factors that have pushed up prices in recent years: commercial oil inventories in industrial countries are lower than their five-year averages; new production growth from non-OPEC producers is weak; and slower economic growth means that members of the Organization of Petroleum Exporting Countries have little incentive to increase production.
For the moment, the apparent slowdown has yet to translate into softer oil demand. In China, for example, Barclays analysts noted that refineries were increasing diesel imports to address severe supply shortages. Diesel imports in December amounted to nearly half the level recorded for the whole of 2007, Barclays said.
Global demand for oil is still projected to increase this year by about 1.5 million barrels a day, according to most analysts. In 2007, demand for oil jumped by one million barrels a day, mostly because of growth in Asia and the Middle East.
But some experts warn that lower economic growth will drive down demand, and therefore prices. Lawrence Goldstein, an economist at the Energy Policy Research Foundation, said that from 2005 to 2007, higher prices had driven down oil demand in the United States, Europe and Japan by 700,000 barrels a day.
As marginal demand weakens, Goldstein said, the tensions on the global energy system that contributed to the market's volatility will likely slacken as well.
"The three pressure points of the market - the lack of crude oil, the lack of spare refining capacity and the lack of product inventories - are all going to be improving this year," Goldstein said. "The problem is what is going to be the real demand growth this year. No one knows for sure, but it clearly will be south of one million barrels a day."
Adam Robinson, an energy analyst at Lehman Brothers, said the declines in oil prices in recent days came as investors gave up on the idea that the world could somehow be immune to a slowdown in the United States.
"You could see prices go down now that this view no longer being subscribed to," Robinson said. According to Lehman's "base case" outlook, oil prices are expected to average $84 a barrel this year. In the investment bank's downside case, oil could fall as low as $65 a barrel this year, the lowest level needed to bring about new investments in oil supplies, Robinson said.
New oil supplies, which have lagged behind demand growth in recent years, are expected to grow by as much as 2.5 million barrels a day, mostly because of investments by OPEC members, and partly because of increases in Russia. While these increases could help rebuild a cushion of spare capacity that has been lacking recently, energy analysts still forecast a tight energy system.
"The market is still fundamentally well supported," Robinson said. "You do have some significant new capacity coming over the next few years. But once Saudi Arabia increases capacity, who then steps up to the plate? Iraq, Venezuela, Russia, Iran, Nigeria? The political situation has to improve significantly in at least one of them. For the moment, no one wants to bet on the politics in these places."

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