CERA: 'Recession shock' shakes oil market

Sam Fletcher
Senior Writer

HOUSTON, Dec. 21 -- The world oil market is being shaken by "a recession shock" that affects all conventional, alternative, and renewable energy," said the chairman of Cambridge Energy Research Associates (CERA).

In a report released at the London Energy Meeting in the UK, Daniel Yergin, also executive vice-president of the IHS information solutions group, said, "The oil price today is the barometer measuring a progressively weaker global economy."

Oil prices have been volatile "on an unprecedented scale" in 2008. "The oil price was driven to its oxygen-short heights last summer by the 'demand shock' that came from 5 years of strong economic growth and was fueled further by geopolitics, oil field costs, financial markets and trading, and psychology," said Yergin.

US demand for gasoline peaked in 2007 and was beginning to decline before the economic crisis broke, but "demand responses were discounted or ignored" in markets where oil is traded, he said. Nevertheless, demand decreased in the face of higher energy prices, "except in those parts of the world where retail fuel prices are controlled or subsidized," CERA reported. The analysts expect total US oil demand in 2008 to be at least 1 million b/d less than in 2007.

At the start of this year, some analysts estimated global demand growth as high as 2.1 million b/d. CERA's current global demand estimate for 2008 is a 300,000 b/d decline and for 2009, an additional 660,000 b/d drop. "The last time demand dropped this much was in the deep recession of 1981," it said.

Supply capacity
The report goes on to say that notwithstanding the weakness in oil demand and prices, oil supply capacity—the difference between total liquids production capacity and actual output—will expand as new supplies, already under development, come to market. That surplus in spare capacity will be a "defining factor" for the oil market," it said.

"Spare capacity will increase significantly in the next few years due to falling oil demand and as supply materializes from investments already under way," said Yergin. "As low as 1 million b/d in 2005 and 2.4 million b/d in 2008, it could reach 7-8 million b/d in 2010-12."

However, he said, "In the medium term, low prices and financial constraints will hinder new investment added. Consequently, as the economy picks up, spare capacity will start to erode and the oil market could begin to tighten again, in the reference case, by 2013 taking the world into a new cycle."

Yergin said, "Another era of strong global economic growth could also accelerate tightness. Conversely, if prices are supported at too high a level, long-term spare capacity will grow to levels that could result in a period of prolonged low oil prices." Among other key factors that the report notes is the potential impact from increased emphasis by governments on greater energy efficiency and alternative fuels.

Meanwhile, he said, "The fall in oil prices is a sort of de facto tax cut—an automatic stimulus package that does not need to be paid for from consumer nation public funds." Yergin said, "If one compares the average US gasoline price in July ($4.14/gal) with October ($2.26) on an annualized basis, the savings to American consumers are $282 billion."

The report concludes that occasional shocks to the global economy and volatility in the oil market are inevitable, but the extremes of price movements from peak to trough can be moderated. Volatility may be an unintended side effect of periods of "consensus about expected future oil prices," and such periods are characteristic of the industry worldwide.

Less future volatility
Greater transparency of market information and data about supply and demand, production and investment, and inventory levels represent key initiatives for limiting future volatility in prices and ensuring a more appropriate match over time between supply and demand—and thus the timely investment that the world economy will need once demand starts growing again.

The report was commissioned by the UK Department of Energy and Climate Change and Saudi Arabia's Ministry of Petroleum and Mineral Resources. The London Energy Meeting was convened by British Prime Minister Gordon Brown, bringing energy ministers and other leaders from around the world together for a summit on the global economy and oil markets. It follows a similar meeting in June at Jeddah, Saudi Arabia.

Contact Sam Fletcher at samf@ogjonline.com

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