Business | Opinion
Oil markets are still in turmoil despite falling prices
Predicting the path of the oil price is a dangerous business. But the answer to this most slippery of conundrums is of crucial importance to the future of the Western world.
- By Liam Halligan, The Telegraph Group Limited
- Published: 23:17 December 14, 2008
Predicting the path of the oil price is a dangerous business. But the answer to this most slippery of conundrums is of crucial importance to the future of the Western world.
Crude costs have plunged since their mid-summer high of $147 per barrel (Dh539.89).
Oil recently dipped below $40 - a staggering 72 per cent fall. Within crude-importing Western countries, there is now a captive audience - including politicians, central bankers and anyone else trying to justify massive interest rate cuts - for the message that energy prices, having recently tumbled, will now stay low.
The danger is the comfort provided by such a view may have imbued it with more credence than the fundamentals suggest.
Can we really assume oil will average less than $50 per barrel next year - as many now do? Could crude languish down at $30? That would certainly keep a lid on inflation and give the Western world a boost. But is it a credible view? On Thursday, crude prices jumped ten per cent - the biggest gain in five weeks.
It is hard to attribute such a sharp rise entirely to sabre-rattling by the Opec exporters' group.
While many blithely assume the days of cheap oil will soon be back - and plug such reassuring assumptions into their economic models - the oil markets are in turmoil.
Volatility - a measure of how rapidly and strongly traders think prices could move - just hit a 22-year high. So are there underlying reasons that oil could soon shoot up?
The basis of the low-oil case is "demand destruction". As the global economy slows, crude use falls, which leads to a drop in prices.
And, it's true, demand has fallen in the US, the world's biggest oil importer, by around five per cent in the third quarter of this year. Other Western nations have also been using less crude.
But the demand destruction argument deserves closer examination. I've often thought at least part of the reason US oil use has fallen is that the breakdown of the payment and credit system means gasoline simply isn't getting to market.
That's certainly borne out by profit margins at American petrol stations, which have spiked - the opposite of what should happen if demand is actually loose.
It's also worth noting that, despite apparently low demand, refined oil inventories in the US and across the Western world are extremely low. Again, that's counter-intuitive if demand really has fallen off a cliff.
What's undeniable is that low inventories mean prices can "turn on a dime" if demand ticks up just slightly - what economists call the "vertical supply curve".
And there are signs that could soon happen. Industry surveys suggest US gasoline use rose 0.3 per cent year-on-year last week - the first increase since April. After all, for the most part, oil is a necessity.
What's definite, though, is that recent price falls, combined with the credit crunch, have slashed investments in oil production. Large crude exporters such as Saudi Arabia, UAE and Russia have lately put major drilling projects "under review", undermining future supplies.
And global oil markets are buzzing with talk of growing evidence that the world's largest fields are now seriously depleting.
Despite their importance to the outside world, oil markets are very murky.
Liam Halligan is chief economist at Prosperity Capital Management
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