For weeks now the stock markets and commodity prices have been falling. Oil is currently trading around $76 a barrel which is close to a 50 percent drop since the middle of July.
Large portions of the credit world’s markets are frozen, a situation which will lead to all sorts of economic problems if not freed up soon. The world’s governments are thrashing around in an effort to revive the credit markets by throwing literally trillions of dollars at the problem, but so far there have been few readily observable results.
This week’s plan involves having the U.S. and European governments spend hundreds of billions in a coordinated plan to recapitalize the banks. The general theory is that if the government owns all, or part, or at least guarantees the banks and their loans, nobody should be afraid of a bank failing, no matter how many bad loans it has hidden on its books. While the latest plan may eventually be enough to restore the credit markets, it seems unlikely to stem falling house prices, save Detroit, or reduce the steady increase in unemployment. If recent polls are valid, America’s voters are becoming increasingly terrified of the future and are in a mood for major changes.
Despite the dramatic drop in oil prices during the last three months, recent developments have only made the supply and demand situation worse. Oil consumption in the U.S. has fallen by 1.8 million barrels a day (b/d) or nearly 9 percent as compared to last year due to a combination of high prices, a slowing economy, and the shortages resulting from the hurricanes that tore up Gulf coast production and refining last month. During September, however, Chinese imports increased by 2 million b/d as Beijing took advantage of the low prices to start building its strategic reserves -so much for falling American demand. The major oil forecasting agencies are now saying that the increase in worldwide demand for oil will slow from rates seen in recent years, but that worldwide oil consumption is still forecast to increase this year and next.
U.S. gasoline prices are down by a $1 per gallon as compared to last July. It will be interesting to see whether U.S. gasoline consumption begins to climb again due to lower prices and the end of the shortages across the Southeast. Although there is a lot of fear in the future, the American lifestyle and economy is still dependent on liquid fuels. While reducing discretionary summer travel is easy, reducing fuel use in daily life is much more difficult.
So far there have been two major reactions to the rapid fall in the price of oil. First we are seeing numerous companies around the world cancel or slow oil and natural gas production projects because prices have fallen too low to make their projects profitable and the outlook for future oil demand is not all that good. The second shoe that will soon drop belongs to OPEC. The cartel has seen the average price it gets for its products drop from $138 a barrel in July to $78 a barrel last week. If the current weakness in oil prices continues, the average that OPEC gets for its oil will be in the $60s.
There have already been reports that OPEC has cut production in the last few weeks, and the organization has scheduled an emergency meeting for mid-November. Analysts are already talking about OPEC cutting production by another million b/d on top of the 500,000 b/d cuts they announced two weeks ago. A mid-November OPEC production decision takes any production-cut/renewed-surge-in-prices problem out of the hands of the Bush administration and leaves it to his successor.
Taken together, the developments of the last few months indicate that despite the steep decline in gasoline prices, the effects of the peaking of world oil production will still be with us. So far the recession we are entering has not been enough to actually reduce worldwide demand for oil, but the drop in oil prices and the overall economic situation is hurting investment in future oil production products.
When these developments come together, be it a few months or a few years from now, world oil production will decline more steeply than would have been expected. Whether this decline comes from a deep economic recession reducing demand or depletion simply getting ahead of new production does not matter — the results will be the same.
The bottom line for this week remains that there is little to cheer about. While oil is dropping in lock step with the equity markets, OPEC is already moving to halt the decline which will not last much longer. At least some of the recent drop in oil prices comes from hedge funds selling off assets to meet margin and redemption calls. If so, this is a one-time phenomenon. With the lower prices we should be seeing in the next few weeks, U.S. demand for gasoline seems likely to start rising again — at least until the economic situation gets much worse.
For now, there seems to be little more to say other than there will be many more surprises in all this. If you have the feeling that events are spinning out of control, you are probably right. Welcome to the 21st Century.