NEW YORK: After surging to record levels this summer, oil prices have suffered a dizzying collapse in recent months, echoing the darkening prospects of the global economy.
Within three months, drastic swings drove oil prices from their peak of $147.27 a barrel to less than $65 a barrel. Oil industry analysts at Goldman Sachs, who had raised the possibility that prices could reach $200 this year, now believe that oil could drop to $50 a barrel in the event of a global recession.
While consumers can cheer the drop, producers have been alarmed at the sudden downturn in their fortunes. Fears of a global slowdown have kicked off a down cycle in the oil sector: It is unclear how long it will last and how low prices will go.
As oil gets caught in the wild gyrations of the financial meltdown, three major questions loom over the oil markets for next year.
What will happen to oil consumption in the United States and in China? How will producers respond to lower prices? Can the oil cartel OPEC stop the slide in prices?
In the past decade, economic growth in emerging countries from Asia to Latin America has propelled a surge in oil demand. Consumption in developing nations jumped by more than 40 percent since 1998 while oil producers struggled to increase their output. That disparity severely tightened oil markets and led to a 14-fold increase in prices from its $10-a-barrel trough to its peak in July.
But high prices and a slowing economy have led to a stark reduction in demand across the industrialized world that probably will outweigh growth in oil consumption from such developing nations as China.
After a quarter century of growth, some analysts say it is quite possible that this year global oil consumption could have its first annual drop since 1983.
In its latest outlook, the International Monetary Fund knocked nearly a percentage point off its forecast for global economic growth for 2009, with developed economies barely able to expand by 0.5 percent.
In turn, that means that global oil demand over the next two years may prove anemic, experts said.
"Oil is integral to the real economy," said Jan Stuart, an energy economist in New York for UBS. "If the real economy goes down, oil goes down. The market right now is trading a long recession and literally no growth in oil demand for years."
Didier Houssin, director of the office of energy markets and security at the International Energy Agency, the world's main forecaster, said there were strong uncertainties about how demand will evolve because of the economic and financial crisis. "That remains a big mystery," he said.
Faced with slowing growth, the International Energy Agency has been paring its forecast for global oil demand since the beginning of the year. But its analysts still see oil demand expanding by 400,000 barrels a day this year, to 86.5 million barrels a day. When the year started, they forecast growth of two million barrels a day for 2008. Some analysts say the energy agency's current forecast is still hopelessly optimistic.
"Despite the IEA's wishful thinking, demand is disappearing very quickly," said Lawrence Goldstein, an economist at the Energy Policy Research Foundation in Washington, who said he expected global oil demand to fall this year. It would be the first drop since the energy shock of the early 1980s.
The double impact of record high prices and slower economic growth has been particularly visible in the United States, which accounts for a quarter of the world's total oil consumption and where demand has slipped to its lowest level since June 1999. Americans have been driving less and flying less this year. Automakers are desperate for a government bailout and airlines are losing billions of dollars.
As a result, U.S. oil demand will probably decline by 5 percent this year, said Stuart, the UBS energy economist.
Similar declines are also taking place in most developed economies, which account for 60 percent of global demand. In Japan, for example, oil consumption in August tumbled 12 percent from a year earlier, while oil use in France has declined 10 percent.
"There is no question the physical oil market has weakened," Stuart said. "The credit crisis has dried up commerce and halted trade, and that has effectively pushed down demand for oil. The trouble is that no one can predict when this is going to end."
Where prices go next year hinges greatly on what happens in developing countries, especially China. Over the past decade, Chinese oil demand has surged by 85 percent, or 3.5 million barrels a day, and has been the main engine that has driven up oil markets. China accounted for a third of the world's extra oil demand last year.
But in recent weeks, there have been concerns that the economy may also be affected.
The chief executive of the global mining giant Rio Tinto warned this month that the Chinese economy was headed for a major slowdown. The World Bank's chief economist said it was unlikely that China would be immune to a global recession. And the chairman of the Industrial & Commercial Bank of China said that demand for Chinese goods was declining.
"As the full effects of the financial meltdown continue to unravel, nudging several OECD countries closer or into recession, there appears to be evidence that key engines of China's growth are already feeling the pinch," PFC Energy, a consulting firm in Washington, said in a research note that referred to the Organization for Economic Cooperation and Development.
China's manufacturing sector, which contributes to 40 percent of the country's economy, has experienced a "marked decline in activity" for several months as its export markets shrink, for example. Still, that is not to say Chinese demand will fall. PFC says it expects consumption to rise by 330,000 barrels a day in 2009, compared with 490,000 barrels this year.
Global oil supplies have also been constrained - and many experts say that they do not expect the picture to brighten much in coming years.
In the past decade, oil companies and producers have been unable to increase their production fast enough to meet demand. For a variety of reasons, including tougher access to resources, political volatility or violence in many oil-producing states, and steadily rising costs throughout the industry, the growth in oil supplies has been disappointing.
Simply, it is getting harder for oil companies and some producing countries to increase production. Over the next two decades, some experts say, oil production will peak at around 95 million barrels a day.
One big problem is that oil fields have a natural rate of decline as oil gets pumped out. The rate varies widely from field to field, but the global average is about 5 percent a year. So, just to maintain output, producers around the world must find and develop about six million barrels of oil a day. To increase global oil production by 1.5 million barrels a day, that figure rises to 7 million or 8 million barrels a day, or at least 2.5 billion barrels a year - a monumental task that gets tougher as production grows.
"The energy crisis is fundamentally a problem of supplies, not of energy demand," said Frédéric Lasserre, the head of commodity research at Société Générale in Paris.
Meanwhile, big producers are struggling. Russian production has been declining in recent months; Mexico's biggest oil field, Cantarell, is in a free fall; Nigerian output has been curbed significantly by rampant violence; and any increases in Iraqi production are contingent on improving the country's security.
"Global oil supply is also falling short of prior expectations," said Arjun Murti, an analyst at Goldman Sachs. "The problem, though, is that investors appear to be placing greater weight on the demand concerns rather than the supply shortfalls; it may require a clear bottoming in global growth sentiment before supply shortfalls are again recognized as a bullish factor."
As prices fall and demand slows, a new concern in the industry is whether oil producers will reduce their investments as prices decline.
Andrew Gould, the chief executive of Schlumberger, the world's largest oil-field services company, has said that producers will probably reduce spending on field development if low prices persist for more than a year.
That view is widely shared in the industry, especially as the credit crunch constrains the ability of many companies to invest.
Meanwhile, the cost of producing extra barrels of oil is rising. As prices fall, this might cause high-cost producers, like those working Canada's vast oil sand deposits, to shut down production or curb their expenses.
"Investments in exploration and production are very much linked to the price of oil," said Houssin of the International Energy Agency. "What we can fear is that the financial crisis leads to delays in many projects. This would create problems for some operators, while the slowdown in demand would not encourage investments in the short term."
The wild card in the oil deck next year will hinge on what actions OPEC takes. As oil fell below $80 a barrel the cartel called an emergency meeting, agreeing Friday to cut output by 1.5 million barrels a day. Just a few years ago, $80 oil would have seemed improbably high. But many producers are now used to high prices - and larger government revenues - and have been spending accordingly. This makes them acutely sensitive to falling prices.
Yet OPEC, which controls 40 percent of the world's oil exports, is quite likely to find it hard to cut output fast enough to halt the slide, analysts said. After the cut announced Friday the price dropped again, ending the week near $60 a barrel. In fact, the Organization of Petroleum Exporting Countries could face a very tough year ahead if demand remains sluggish.
"The irony is that for OPEC $80 a barrel is a crisis," said Goldstein, the economist. "OPEC members have put on their crisis management hat because they realize that demand is slipping quickly from them."
In the longer term, however, many analysts point out that the world is likely to see prices jumping back above $100 a barrel. Population growth and economic activity are both rising, and with it the demand for oil, for which there is no easy or ready substitute, particularly in the transportation sector.
Given the constraints on supplies in coming years, this means tight markets are here to stay. In fact, some analysts warn, the lower oil prices fall in the next years, the sharper the rebound will be when the economy - and oil demand - finally picks up.
6 months ago