Author Topic: Will oil prices recover after tanking in 2008?  (Read 1410 times)

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Will oil prices recover after tanking in 2008?
« on: December 31, 2008, 12:22:39 AM »

The oil price gyrated wildly in 2008 `“ but what's in store for the price in 2009, asks Garry White.

Oil prices have experienced wild fluctuations in 2008

Last Updated: 5:56AM GMT 30 Dec 2008

The oil price gyrated wildly in 2008, hitting an all-time high above $147 a barrel on July 3 `“ followed by four-year lows. The big question now is: Where next?

Until the credit crunch saw global markets freeze, demand for oil had been rocketing, mainly because of rapid development in countries such as India and China.

However, the financial crisis changed that. Demand plummeted in the latter part of 2008 and global inventories grew. In the third quarter of 2008, US oil consumption shrank by about 1m barrels per day (bpd) `“ or around 5pc. It is likely to have fallen further in the fourth quarter.

To keep the market in balance, Opec cut supply. In December, the cartel, which controls 40pc of global oil output, agreed its deepest cut ever, bringing the total cut in quotas in the second half of 2008 to 4.2m bpd.

But even this failed to support the price, which fell almost 10pc in the next two sessions.

There were two reasons for this fall. It is obvious that demand deterioration continues as the
global economy falls deeper into recession, but the market was also sceptical whether Opec members would comply with the cut. This followed news that only 85pc of the previous 1.5m barrel quota reduction had been implemented.

The latest cut of 2.2m bpd is due to start on January 1. Analysts are unsure whether members will stick to their production quota, so there is uncertainty about oil supply over the next few months.

Then there's Russia, the world's second-largest oil exporting nation. Opec had hoped the country would join in with co-ordinated cuts in output. Russia sent its highest-level delegation ever to Opec's December meeting, but said it was not going to join in with Opec's actions. US pressure was probably behind Russia's decision. Analysts warned that Congress could campaign to have Russia thrown out of the G8 if it got too close to Opec.

One other cause of the oil-price spike was a slide in the value of the dollar. As the currency weakened investors bought dollar-denominated assets as a hedge against inflation, helping propel oil to close to $150 a barrel.

However, the global economy's deterioration saw investors repatriate assets they saw as risky. This caused a flight back into cash and these positions were unwound.

Over 2009, the currency markets are likely to be volatile and difficult to predict. If dollar strength persists, this is likely to keep the oil price subdued.

However, the Federal Reserve has slashed US interest rates and signalled that it could soon be printing money to try to stop the recession turning into a depression. Many analysts feel that this will be bearish for the dollar, and a dollar fall would once again boost the oil price.

Ultimately, what happens to the oil price depends on whether the recent fiscal stimulus packages work. If they do and economies improve then demand recovery will be bullish for the oil price.

If the packages fail the outlook for a recovery in oil prices is bleak. Economic contagion in the West is already hitting China's manufacturing base.

Earlier this month Merrill Lynch oil analyst Francisco Blanch said the oil price could drop to $25 in 2009 if China falls into recession. He put the chances of this happening at one in three. However, he added: "If we reignite economic growth, we will have a shortage of energy again." In this case, Mr Blanch predicted oil at $150 a barrel in two or three years.

Most analysts are downbeat on the oil price in the short term. Deutsche Bank analyst Michael Lewis said: "Many commodity prices are set to overshoot to the downside in response to the worst downturn in economic activity since the Great Depression."

In the long term, low oil prices could be damaging, as they stop investment in the discovery of new sources. Speaking at a recent summit of energy ministers held in London, Gordon Brown warned that if nations cut investment in oil production, demand will eventually exceed supply again, forcing prices up.

Geo-political issues may also come into play. The escalation of attacks between Israel and Hamas in Gaza caused a spike in the oil price on Monday. If problems persist in the region this is likely to provide a floor for the oil price in the early part of the year.

There are also the actions of the Movement for the Emancipation of the Niger Delta (MEND) in Nigeria. Attacks by the rebels contributed to the oil price spike in early 2008, as the country is the world's eighth-largest crude oil exporter and the US's fifth-largest source for imported oil. Major exporters Iran and Venezuela also continue to sabre rattle with the US, which could prompt more supply fears.

Ultimately, however, the outlook for the oil price in 2009 depends on where or not government action to tackle the economic crisis works. Mervyn King has warned that the UK could flirt with deflation in 2009 `“ and if deflation becomes a major global problem the outlook for the oil price is decidedly bearish.

Should the stimulus packages start to work and become reflationary this would be bullish for the price of oil. When it comes to the direction of the oil price in 2009, it's quite simple really `“ as Bill Clinton once said: It's the economy, stupid.
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