RISE AND FALL OF CRUDE OIL PRICES

CONSUMPTION EXPECTED TO REMAIN LOW DURING RECESSION

SHABBIR H. KAZMI
Jan 19 - 25, 2009

Crude oil price closed around $45 per barrel on the last day of 2008 - surging 14% during the final rally and wrapping up the most turbulent year ever in the history. In just five months, crude has given up four years of gains in a stunning collapse as the world's leading economies sank into recession.

Oil had been rising steadily since 2002, jumping 57% in 2007 to nearly $96 a barrel. That climb only accelerated in 2008, fueled by speculation that soaring growth from China, India and other emerging economies would outpace demand for crude while a weaker dollar helped driving prices to a record $147.27 a barrel on July 11, 2008. But the oil bulls were soon slaughtered.

Prices tumbled as a mortgage crisis in the US blossomed into a world phenomenon. Not even hurricanes Gustav and Ike in the Gulf of Mexico in September or the Middle East conflict between Israel and Hamas have been able to stop crude's slide.

The high price of oil spurred so much production that the globe became awash in oil. The January contract, which expired December 19, settled at $33.87, the lowest level since early 2004 as brokers and traders attempted to unload supply for whatever price they could get.

What should one expect in 2009? Every one has his/her rationalization but each statement indicates the motive and the wish. The general perception is that the slide in oil prices is over and there is a strong likelihood that these will bottom in January and take a U turn after February contract expires on January 20th.

However, this doesn't necessarily mean that the oil bulls are about to start running again. The key factor driving oil prices in 2009 will be the depth and length of the global recession. One view is that the demand for crude will probably be higher in the US but elsewhere in the world it will be slower to rebound. Others believe that China and India will shortly outstrip the US consumption because of its slower recovery.

In January 1999 the price of oil reached a low point of $16 a barrel as Iraq increased its oil production at the time of the Asian Financial Crisis when demand for oil fell. Prices then increased rapidly, reaching $35 in September 2000, and after a temporary fall reached $40-50 by September 2004. Prices surged to a record high of more than $60 in June 2005 and by early August 2005 hit $65 as consumer demand was maintained. In September 2007, the price of US crude oil broke the $80 barrier. In October 2007 price of a barrel of US light crude oil exceeded $90 for the first time, due to a combination of tensions in eastern Turkey and a fall in the value of the US dollar.

The next psychological watershed of $100 was briefly breached in early 2008, but the price fell again until the end of February after which it remained and rose well above this new setting. Then a visible ramping effect became evident and the price surpassed $110 on March 12, 2008; $125 on May 9, 2008; $130 on May 21, 2008; $140 on June 26, 2008; and $145 on July 3, 2008. The record was reached on July 11, 2008 at $147.27 as a consequence of geopolitical tensions over Iranian missile tests.

One tends to believe that the price of oil is highly sensitive to the world political situation and to a general sense of confidence. When it touched $147 level the perception was that there would be no stopping and by December 2008 a barrel of oil might cost around $150 and by the end of 2009, it would be close to $200. However, oil prices declined by more than $20 in July 2008, and seemed to stabilize near $125 a barrel on July 24, 2008. A forcing factor came into play, which was that the very high price of oil had changed people's behavior and they were now consuming less.

Oil prices then dipped further, reaching $112 a barrel, on August 11, 2008. On September 15 the $100 psychological barrier was again broken when the price fell below $100 for the first time in seven months. On October 11 there occurred a massive crash in the value of global equities, with a barrel of oil falling below $78.

In consequence of further economic slowdown the price continued to slide and on December 4, 2008 it traded around $45 a barrel. Rather than the $200 predicted last summer some analysts are now predicting a $20 barrel sometime during 2009. However, even if this does happen it will be a short-lived event, because the facts of geological limits to production, increased production costs to obtain more difficulty recovered oil and that demand is still rising, though less steeply.

The upshot will be a gap between the demand for crude oil and the limits of how much of it can be produced, a quantity that must inevitably fall beyond the point of arrival of "peak oil", which will force the price up again. Thus oil will become a commodity that is both increasingly scarce and relentlessly expensive. The price of oil is subject to major variations over time, since they are inextricably linked to the overall business cycle. When the demand-supply gap is reached, oil prices will soar, but the commitments and habits that determine the energy use will take time to adjust.

The remarkable hike in the price of oil in the summer of 2008 was driven partly by a period of brevity when global demand for oil outran its supply. The OPEC nations were encouraged to ramp-up their production to get the price down for western nations who would be unable to maintain their demand for oil if its price remains at such high and relentlessly increasing levels.

Job losses and less disposable income then means that many in the low-income bracket would be unable to payback their mortgages and a credit crunch ensues, with a lack of confidence in and among banks who lent money rather carelessly. The level of output by OPEC along with a contraction and the threat of further slowdown in the business have created a minor glut.