Falling Oil Prices: Worrying Trend or Saving Grace? by Marin Katusa,
The “warning signal†that is currently flashing red is the Oil Expense Indicator, which is the share of oil expenses as a proportion of worldwide gross domestic product (specifically, it is oil price times oil consumption divided by world GDP).
Since 1965, this indicator has averaged roughly 3% of GDP and has only exceeded 4.5% during three periods: in 1974; between 1979 and 1985; and in 2008. Each period saw severe global recessions.
In 1973/‘74, the Arab oil embargo sent oil prices rocketing skywards in the world’s first “oil shock.†In 1979, a revolution in Iran knocked out much of that country’s oil output and catalyzed the world’s second oil shock.
And, of course, in 2008 the housing bubble collided with speculative buying of new debt instruments and a commodities boom to propel oil prices to a record high of US$147 a barrel, which helped to trigger the global financial crisis and the worst slump since World War II.
So where are we right now? Well, Brent crude prices would have to fall to the low US$90s per barrel for the Oil Expense Indicator to drop below 4.5%.
Instead of that, Brent prices have been above US$100 per barrel for more than six months (aside from an intraday low of US$98.97 on August 9) and are still hovering between US$105 and US$110.
Merrill Lynch analysts agree, writing in a recent note: “The last two times that energy as a share of global GDP neared … the current level, the world economy experienced severe crises: the double dip recession of the 1980s and the Great Recession of 2008.â€
So we face two options: oil prices come down sharply, or we enter a recession, which will drag oil prices down. Either way, crude has to get cheaper.
On top of that, no one is yet predicting a reduction in global oil demand. The International Energy Agency (IEA) reduced its forecast for demand growth, but still expects the world to consume 1.2 million more barrels of oil each day next year than this year.
Similarly, OPEC reduced its demand growth estimate, but still foresees oil demand rising by more than 1 million barrels of oil a day over the next 12 months.
So, oil prices will come down when the economy falls too, but if oil goes on a tailspin à la 2008, expect to see OPEC step up to the plate, tighten the market, and support prices, so that its members can continue to pay their bills.
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