As you may remember from last summer, there has been a major bubble in the oil price recently. From a high of $147 in July 08, the price of crude collapsed to $40 a barrel by the end of the year. The price was grossly inflated by speculators, and it had to come down. The bubble has consequences however, that we may not have seen quite yet.
Because the price of oil has risen steadily for several years, oil companies have had full confidence that any investment they carry out will pay off. New pipelines, refineries and so on make sense, meeting rising demand, and paid for by rising prices. With prices at record highs in the last couple of years, oil companies were planning a lot of investment to make the most of the big profits.
When the bubble burst and the price dropped through the floor, those investments were no longer sound. In light of plummeting prices and a global recession, oil companies pulled the plug. A project in the North Sea that was due to increase yields from the UK’s Forties field was cancelled. China postponed a number of projects, and Kuwait cancelled a $15 billion fourth refinery.
Oil demand has dropped off with the recession, and so oil supply has kept pace. The problem will come when the economy turns a corner. As the recession eases off and the economy starts to grow again, those cancelled investments will create a lag between demand and supply. That will lead to another price spike, which may pull the economy back down again. That may be at the end of the year, or early 2010, depending on what the global economy does over the coming months. Either way, an oil shock looks highly likely.
The global response to the financial crisis has been to prop up the markets and restore the status quo as quickly as possible. The current oil situation means there is no status quo. The growth economy cannot function in a world of dwindling resources.
- Look out for more on the oil situation this week – the International Energy Agency publishes its latest oil market outlook today.