Business | Oil & Gas
US recession could cut oil prices by $10 a barrel
Fears of a US recession and an increasingly co-relation between equity markets and oil prices could drive the price of crude down by as much as $10 per barrel, global investment bank Merrill Lynch said.
- By Babu Das Augustine, Banking Editor
- Published: 23:39 January 29, 2008
Dubai: Fears of a US recession and an increasingly co-relation between equity markets and oil prices could drive the price of crude down by as much as $10 per barrel, global investment bank Merrill Lynch said.
"In our view, a relatively mild US recession will only have a very small impact on transportation fuel demand due to the lack of substitutes," said Francisco Blanch, commodity strategist with Merrill Lynch.
"The correlation between the US industrial cycle and oil demand has dropped to 30 per cent during the past 10 years, as 70 per cent of US oil demand is now linked to transportation. Still, a turning industrial outlook suggests that a $10 per barrel reduction in crude oil prices from current levels is possible," he said.
Analysts expect a surge in crude oil inventories during the coming months. Apart from the fear of US recession, Merrill Lynch analysts see the strong correlation oil has with stock market as a decisive factor in the short to medium-term oil price movements.
"Equity markets have been caught up in the unwinding of global imbalances. As a result, crude oil has been 85 per cent correlated to the stock market in recent weeks on an hourly basis, highlighting that a bear market could put temporary downward pressure on oil. Once macro uncertainty subsides, we expect this correlation to break down," said Sabine Schels, commodity strategist, Merrill Lynch.
The sharp downturn in equity markets does have an important message for the crude oil markets. After six years of record profit growth, the corporate earning outlook is deteriorating both in the United States as well as in Europe.
Tighter credit conditions is likely to translate into slower rate of activity in the first half of this year. In turn, this implies rising costs of capital and a slowdown in loan growth. The expectation of a deteriorating earnings outlook ultimately reflects the view that economic activity could deteriorate in the coming quarters, Merrill Lynch said.
On the macroeconomic front, Merrill Lynch analysts said the US attempt to tame the recessionary trend through measures such as rate cuts and $145 billion fiscal stimulus package will help only to ease some of the short-term pains related to a deceleration in the US.
In doubt
While the real interest rates are already in the negative territory, the efficacy of further rate cuts in fighting slowdown is in doubt, and although fiscal stimulus package is likely to help the sagging economy, this would mean the US going deeper into debt.
Irrespective of whether the US economy ultimately slips into a recession, analysts said that judging by the latest Institute of Supply Management (ISM) data, US production in December contracted by the sharpest monthly rate in almost four years, suggesting a slowdown in US energy demand ahead.
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