Oil Bubble and the 2008 Recession

It's hard to believe that oil is now trading below US$36 per barrel, because it hit $145 less than six months ago. In 2007, OPEC has an opportunity to at least slow, if not to reverse the steady rise of oil prices, which were then testing at $90.

Despite experiences that oil shocks have preceded every U.S. recessions since 1972, except the post-September 11, 2001 recession, OPEC did nothing. OPEC meetings served only as information dissemination opportunities to blame the rising price on many things, except, lack of increase in OPEC production. In fact, what OPEC did during this phase of the oil cycle was to test the limits of the market, and to determine the maximum price the market could bear. Or, in other words, OPEC members were repeating the mistakes of 1990-1991 recessions.

OPEC, by focusing on short-term national revenue, and by failing to increase production has derailed the U.S. economy and driven it into a recession. This led to oil demand and oil's price collapse- to levels no one could predict. Finally, it only acted recently in response to steep and sudden falling prices.

OPEC, the oil-exporting cartel, pumps 40 per cent of the world's oil, has already slashed its output twice this year by about 4.2 million barrels a day. But the production cuts, agreed in September and October, failed to stop prices fall. The US new demand data for September shows- 13 per cent demand contraction in oil products consumption, with oil inventories growing everyday. Even the Chinese behemoth is slowing down. It looks like that the global slump will get worse than currently expected. Energy demand will fall further.

Forty dollars per barrel could be considered high- until the past three years. Even during the first Gulf War, oil only kissed $40 for a week before tumbling back to the teens- where it stayed for a decade. Oil didn't touch $40 again, even after 9/11 (it actually fell) and neither did it during the 2003 invasion of Iraq. Oil started trending up only recently, to an astonishing $145.

The point is that an oil bubble propelled its price to $145 per barrel, and then burst several months ago to a realistic $40 per barrel level. Once again, a miscalculation by OPEC, probably motivated by greed or rational self interest, has resulted in almost the same set of market conditions, when OPEC made the same mistake in 1990-1991.

"If you take into account all the subsidies involved in the production of a barrel of biofuels, I doubt whether anyone could make money out of biofuels, if crude price is lower than $70," Saudi Oil Minister Ali Al-Naimi said with confidence and a shade of arrogance back in February- when oil first approached the $100.

At present costs of production, oil prices below $50 a barrel is an anomaly and defies the fundamentals. Oil well in deep water, it requires a $70 per barrel price for it to be a good investment; while oil sand extraction in Canada requires a price near $50. But some economists have predicted that it could fall as low as $25 a barrel in 2009.

Prices that low -- and their equivalents at the gas pump -- will no doubt be viewed as a godsend by many hard-hit American consumers, even if they ensure severe economic hardship in oil-producing countries like Nigeria, Russia, Iran, Kuwait, and Venezuela that depend on energy exports for a large share of their national income.

In good times and bad, oil will continue to supply the largest share of the world's energy supply. For all the talk of alternatives, petroleum will remain the number one source of energy for at least the next several decades. According to December 2008 projections from the U.S. Department of Energy (DoE), petroleum products will still make up 38% of America's total energy supply in 2015; natural gas and coal only 23% each. Oil's overall share is expected to decline slightly as biofuels (and other alternatives) take on a larger percentage of the total, but even in 2030 -- the furthest the DoE is currently willing to project -- it will still remain the dominant fuel.

A similar pattern holds for the planet as a whole: Although biofuels and other renewable sources of energy are expected to play a growing role in the global energy equation, don't expect oil to be anything but the world's leading source of fuel for decades to come.

Low prices, as at present, are bad for producers, and so will hurt a number of countries that the U.S. government considers hostile, including Venezuela, Iran, and even that natural-gas-and-oil giant Russia. All of them have, in recent years, used their soaring oil income to finance political endeavors considered inimical to U.S. interests. In Iran, public works projects are being abandoned en masse. Crude oil represented 80% of Iran's government revenues “What has the government done with $200 billion in oil revenues?" read one Iranian newspaper's headline. The answer is obvious -a nuclear program and the subsidy of its colony, Syria, and its expeditionary terrorist army, Hezbollah. Iran's economic problems affect Hezbollah's war of attrition against Lebanon and Israel.

In Venezuela, like Iran, Venezuela is heavily dependent on oil -- it represents 80% of its exports, and accounts for 50% of its government revenues.

About half of Russia's budget comes from oil and gas; and energy accounts for 20% of Russia's GDP. That's what's been funding Russia's provocative nuclear bomber flights over Canada's Arctic, and the Russian navy's excursion to Latin America.

However, dwindling prices could also shake the very foundations of oil allies like Mexico, Nigeria, and Saudi Arabia, which could experience internal unrest as oil revenues, and so state expenditures, decline.

By katherine Marfal