Oil Prices Could Hobble Global Economic Recovery

Riyadh, Saudi Arabia, 15 August 2009. The Chief Economist of the IEA has warned that oil prices staying about $70 a barrel could threaten the strength of the global recovery.[br]

Riyadh, Saudi Arabia, 15 August 2009. The Chief Economist of the IEA has warned that oil prices staying about $70 a barrel could threaten the strength of the global recovery.[br]

This is a timely warning as oil prices once again edge over the $70 mark, as they have for most of August. Why that is the case, however, is generating some debate. The US Department of Energy statistics show that US stockpiles are building, and are 20 per cent higher than this time last year. Gasoline demand has not yet rebounded. Cheaper gas prices are more than offset by the recession cutting consumer car usage.

There are also downward price pressures from the supply side. The Organization of Oil Producing Countries, or OPEC, had recently cut production quotas to 4.2 million barrels a day. However, with the finances of many oil exporters in dire straits, it is believed that production level have been quietly raised, to take advantage of these higher prices and refill some government coffers. In theory, this should be a further dampener on prices. [br]

“There are two reasons why oil prices could be showing such strength now, ” said Hosni Afleck, Chief Economist at EconomyWatch.com. “Firstly there is the question of rising demand from developing countries. China in particular is looking to secure additional supplies and build up its reserves, as it believes prices are only headed upwards in the medium to long term.

“This is leading to forecasts of increased consumption this year, which the IEA has just re-forecast at 83.9 million barrels a day. The second factor, which is a bit hard to measure, is the impact of oil investors and speculators. Mutual fund and ETF managers have increasingly been looking at oil as part of investment portfolios, while individual speculators and hedge funds have been making big bets on price movements up and down. All this, we believe, exaggerated the price moves up and down last year. Now, the aggregate view is bullish, and the ‘punters’ are getting their bets in early.”

The US outlook in particular provides some evidence to support this theory. Estimates show that US output is declining at 4 per cent per year. On current trends, America will need to import more than 75 per cent of its oil and gas needs by 2012. Demand from emerging economies will grow strongly during that period, mature fields around the world will increase the decline of their productive capacity, and new sources in countries with large reserves, such as Iraq, will take time to kick in.

Although short term prices may be distorted, the long term trend is clearly upwards. The question now is whether economic recovery will come quick enough to absorb those higher prices, or if short-term price growth kicks dirt over the green shoots of recovery, leading to a W-shaped world recession.

Dwayne Ramakrishnan, EconomyWatch.com