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There aren’t many reasons to be cheerful at the moment, but the massive collapse in the oil price is one of them. As recently as July, oil scaled the record-breaking heights of $147 a barrel – pushing up petrol prices, the cost of heating, and inflation.
But since then, the fear of global recession and falling demand from emerging markets has brought oil down to under $50 a barrel. That is good news for the flagging global economy, since it will lower the cost of production, and make transportation cheaper.
Back in the summer, Barclays Wealth research suggested that a long-term sustainable value for the oil price was around $80 a barrel. That was way below the price at the time, and we did not expect the price to fall much before the end of 2008.
“As it turned out, our rather modest prediction didn’t go anything like far enough. The collapse of Lehman Brothers and the credit crunch caused a huge demand shock. And demand for oil fell far more, and far more suddenly, than we ever pencilled in to our forecast,” note Barclays Wealth analysts.
Oil and trouble
As we race towards the end of the year, with the oil price down to below $50 a barrel, now seems like a good time to revisit our forecasts. But what are the big, lasting issues that affect the oil price?
The first and most important factor is good old supply and demand. Whenever the global economy grows fast, demand for oil outstrips producers’ ability to supply it. And that means that the global inventory of oil gets run down. So just looking at current oil inventory levels, and demand, can help predict oil prices.
The decisions made by OPEC, the cartel that produces around a third of the world’s oil, usually also have a big impact on price. If OPEC decides to cut production, then usually, the oil price is likely to rise. However, OPEC’s last cut in October had no discernable effect on the oil price.
It isn’t always that simple, because OPEC countries have been known to bend the rules on their quotas. For example, they tell other members they will cut production but don’t actually do so, or at least not as much as they have promised on paper – particularly when cash is short. So a large cut in OPEC production doesn’t always translate exactly into a proportionate move in the oil price.
In addition, it isn’t enough just to get raw oil out of the ground – it has to be refined before it’s usable, and that has an impact on the price. Sometimes, refiners can struggle to convert oil quickly enough to meet demand. Hence, the state of the refining industry can affect the oil price. And finally, speculators can have an impact on oil prices. Oil prices tend to rise faster when the futures market is already priced for oil prices to rise.
The $64 question
So taking all these factors into account, what do our models say now? Well, in the longer run – towards the end of 2009 – Barclays Wealth analysts think the oil price will recover from its current level, but only slightly.
“By then, we expect it to be around $64 per barrel,” say Barclays Wealth analysts.
But before then, demand will continue to fall, as global recession really starts to pinch. Oil prices may drop even further in the short term, before eking their way back to the low $50s by the middle of 2009. Admittedly, there are some much wilder forecasts around. But if we’re right, then the oil price should be a rare bright spot in the economic landscape for some time to come, conclude Barclays Wealth analysts.
