Oil Market in previous US recessions

Bank of Canada economists Olivier Gervais and Ilan Kolet have written a useful paper on oil cycles. It tells you about the oil markets in 1973 and 1979 oil shocks  and compares the trends with 2007 crisis. The charts are quite interesting. In 1979, the demand fell much sharper but prices have corrected much more in this crisis. Why should this be?

What is particularly interesting is the relation between current oil prices and investment levels. They say current depressed prices have led to lower production and lower incentives to undertake more investments in oil sector.

The dramatic reduction in global demand, and the decline in the spot price of crude oil in the second half of last year, may have significant implications for the future supply of oil. Investments in conventional methods of extraction have been constrained, since easily accessible oil reserves are typically concentrated in countries with geopolitical uncertainty and/or state-run oil companies. Moreover, nearly half of all global oil production, and roughly 75 per cent of proven reserves, are accounted for by the Organization of the Petroleum Exporting Countries (OPEC).

In this paper, the authors assess the implications of recent developments for the future supply of oil. They find that (i) the OPEC cuts announced in December 2008 could provide important support for prices in the coming year, and (ii) low prices have depressed, and may continue to depress, oil infrastructure investment, and thus could amplify existing supply constraints.

The conclusion is:

The recent drop in oil prices has already had an impact on investment in the oil sector. A growing number of investment projects are suffering from delays and cancellations. The weak investment outlook will likely result in further declines in non-OPEC oil production and could put upward pressure on prices. Furthermore, the magnitude of the recent OPEC supply cuts far exceeds the expected declines in oil demand in 2009, which suggests that the cuts are an explicit attempt to increase crude oil prices. At the end of the recession, global demand for oil is expected to increase, and non-OPEC investment projects may not have enough of an impact on the oil supply to offset robust demand. Even if the situation appears to resemble that of 1981, where oil prices remained low for a long period, we expect that the increase in emerging-market demand, coupled with the tepid supply response, could result in oil prices reaching $80–$100/bbl by 2011.

Hmmm. Only USD 80-100 by 2011. The way prices have risen it seems we will touch this range much sooner.


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