If the US bubble is pricked can the fall be controlled? Pt 2 Is recession driven by the price of oil or will it drive the price down? Oliver Morgan looks at the options for the producers' cartel Sunday January 7, 2001 The new millennium opens to an intriguing tale of two cities. Later this month, the eyes of the world will be on Washington, where a president - half of whose people do not want him - will be inaugurated. His investiture comes as his country threatens to dive into recession, possibly dragging Europe and the UK down too. Just before that, in Vienna, the leaders of the world's most important cartel, the Organisation of Petroleum Exporting Countries (Opec), will meet to try to manipulate the price of oil. According to some observers, the activities of the latter over the past two years - when from the spring of 1999 Opec cut oil production, triggering a surge in crude prices from $10 a barrel to $35 - have determined the inauspicious inheritance of the former. Professor Andrew Oswald of Warwick University argues that history shows recessions following oil price hikes as night follows day. He feels vindicated. 'If you look historically, rises in the price of oil have been a very good predictor of world recessions - in the early and late Seventies, and in the early Nineties. That timing is coming true again,' he says. It is not simply history; it is fundamentals. Despite the talk of a weightless, oil-less economy, tipped into recession by the bursting of the dotcom bubble, Oswald says: 'Oil is the largest source of energy on the globe, and you only have to look at any modern economy to see how fundamental energy is to its way of life.' But the world moves on. Oil prices tumbled in December - from $35 to about $25 in barely more than a trading week, prompted by the delayed effects of cumulative increases in Opec production last year of 3.7 million barrels a day (mbd). This fall is what is focusing attention on Vienna, where Opec meets in two weeks. Saudi Arabia - traditionally an Opec 'dove' - has been calling for a 1.5 mbd cut in production (5.5 per cent of Opec production and nearly 2 per cent of global consumption) to shore up the price to the mid point of its $22-$28 target range. But traders say this is unlikely to happen. Salomon Smith Barney forecasts the 'Opec basket' benchmark to trade at an average of $20.50 this year, compared with $27.60 last year - a 25 per cent fall. Salomon's Carlo Moccia points out that the price was sustained by worries over shortages of crude oil, gasoline and more recently winter heating oil - particularly in the US, which consumes about 20 per cent of the 76 mbd production. He says: 'Typically there is 70-90 days' forward cover for demand for products. In September 2000 that came down to as low as 40 days. [This was when the US government took the extraordinary step of releasing its strategic oil reserve to boost supplies.] 'When we get to a level, possibly as soon as January, where forward stocks will last through the winter, we expect the oil price to come down sharply, to as low as $15. Prices may stabilise in the second and third quarters.' These arguments are well recognised by some of the Opec states. Hawks such as Kuwait have been arguing for a 2 mbd cut. Analysts, who do not have to make predictions, are more reticent about prices. Dr Manouchehr Takin of the Centre for Global Energy Studies points out that inventory figures are now more comfortable . But he says: 'It is hard to judge simply by the published numbers, because they are difficult and arrive late. We do not know how much oil has been consumed, and this is more difficult to estimate because consumers did a lot of panic buying last summer.' Add to this the question of Iraq, which at the beginning of last month cut off its 2.3 mbd supply after demands for 50 cent surcharges above prices agreed by the United Nations' oil-for-aid programme were refused. The aims of Iraqi leader Saddam Hussein - to promote an oil crisis and test President-elect George W. Bush - were frustrated as crude prices plunged. Iraq resumed some exporting last month. However, it is unclear what Saddam will do next (exports have been halted again since 31 December) or whether an Iraqi cut will be in place when and if Opec decides on one later this month. More broadly, UK oil analyst Steven Turner points out: 'We all know it is much more difficult for Opec to manage cuts in output than rises, because individual countries do not want to cut their revenues.' Lower prices - if they do stay low this year - will impact on the slow-down scenarios being painted in Washington and London. Oswald expects a similar pattern to that of 1990-91, with lower prices feeding into a recovery next year. He says: 'Undoubtedly part of the reason for the $10 drop is that the market has taken a view that the world economy is slowing, and that the demand for oil will slow, therefore the price will fall. This is the next stage of the process, an automatic correction.' Others would argue that oil prices no longer determine recessions; rather, recessions determine oil prices. Economists do expect the oil price to provide some counterbalance if a US-led slowdown materialises later this year. In the UK, David Hillier of Barclays Capital says: 'For the first three quarters of the year, lower oil prices are going to push inflation down to closer to 2 per cent rather than the 2.5 per cent Government target.' Hillier has adjusted his oil-price forecast for 2001 from $28 to $22, which delivers a 0.2 per cent drop in inflation. This, he believes, will help offset the inflationary impact of what appears to be stubborn consumer demand on the high street - evidenced by strong Christmas trading. In this scenario, if recession comes, oil will not be a contributory factor, as it was during the 'stagflation' of the Seventies. The outlook is anything but clear. Paul Horsnell of the Oxford Institute for Energy Studies says: 'The price will be difficult to predict over the coming year: I expect more volatility. The key problem is creaking infrastructure - when you are running refineries at 95 to 97 per cent capacity, there is little margin for error.' Further off, Oswald believes oil will continue to maintain its influence over the global economy. 'This is the first time in history that we have seen a doubling of the oil price without a war. That is a signal of long-term oil demand.' And for those who say the US and Western economies are no longer as oil-reliant as they were in the Seventies he says: 'You have to think about China. It has five times the population of the US, and at the moment has one-twenty-fifth of the vehicles. You don't need a PhD in economics to see that demand is going to soar.' Guardian _______________________________________________ Crashlist website: http://website.lineone.net/~resource_base
