Recession likely to fuel another roller-coaster ride for oil in 2009

Tamsin Carlisle

• Last Updated: December 20. 2008 11:53PM UAE / December 20. 2008 7:53PM GMT

It was the year that broke the banks and the back of the global economy. For oil prices, it was the year of the superspike.

And for governments and companies making plans for the year ahead, it was a year that bequeathed them a massive dilemma: whether to count on oil prices staying near their current level of below US$40 barrel – roughly a four-and-a-half year low – or to brace for further wild price swings.

Starting this year with a bang, crude prices thrust into triple-digit territory on Jan 2, the first day of trading, setting the scene for an unprecedented rally to nearly $150 a barrel seven months later. At the close of the year, that rally fizzled just as dramatically, leaving producers and consumers alike pondering whether the oil boom was just taking a breather or had gone bust.

“I think anyone you talk to would have to be surprised by the magnitude of these huge price swings. This is extreme price volatility that no one can predict,” said Jim Ritterbusch, the president of the energy consulting firm Ritterbusch and Associates.
The rally had to wait a month to get started. Early signs of a weakening US economy caught investors’ attention in January, sending oil down. That augur of slowing growth in oil demand – the first in six years – would eventually prove prophetic.

But in February, investors seeking a refuge from the falling US dollar and moribund stock markets piled into commodities. And crude’s upwards spiral piqued renewed public interest in the “Peak Oil” theory proposed in 1956 by the US geologist M King Hubbert.

The theory’s advocates, believing the price surge meant the world was running out of oil, gained political acceptance by embracing the corollary that an immediate large-scale shift to clean energy alternatives was essential to save the planet from descent into an energy-starved chaos. This added to Peak Oil’s popular appeal, boosting the shares of alternative energy companies and makers of electric cars.
”Our view is that oil production will peak in the near future. We need to develop power trains for alternative energy sources,” Katsuaki Watanabe, the president of the car maker Toyota, said in June.

Some Gulf oil producers also jumped on the clean energy bandwagon, the UAE among them. Abu Dhabi Future Energy Company, or Masdar, announced a series of costly developments with foreign partners, including a $2 billion (Dh7.34bn) scheme to build a hydrogen-fuelled power station and carbon-capture and storage project, a $2bn investment in the manufacture of thin-film solar cells, and an international joint venture to build solar power plants.

With oil prices now about 70 per cent off their peak, the economics of these projects are looking increasingly dicey and some may face delays. Still, the Masdar chief executive, Sultan al Jaber, remains convinced of the wisdom of developing clean energy in the Middle East.

“What better investment can Abu Dhabi ever venture into, other than investing the resources that you have today, from the oil and gas sector, into securing and finding new sources of energy for the future?” he said last month.
Another factor driving up oil prices earlier this year was the market’s sensitivity to any perceived geopolitical threat to production or exports, especially in and around the Gulf. This foreshadowed concerns that the US president-elect, Barack Obama, voiced in August, when he pledged to end US “dependence on oil in the Middle East”.

Back in February, the main threat to the region’s stability was a Turkish military campaign against Kurdish separatists based in northern Iraqi provinces that did not produce any oil. Although the turmoil did not obviously jeopardise international crude supplies, prices turned upwards. Later, Kurdish insurgents sabotaged major oil and gas export pipelines crossing Turkey in a series of attacks, indicating the early concerns were well founded.

More direct threats to oil supplies included sabotaging Nigerian oil facilities, increasing resource nationalism in oil-producing states from Algeria to Venezuela, and the international row over Iran’s nuclear aspirations. The last prompted the Islamic Republic, Opec’s second-largest oil exporter, to flex its military muscles and issue repeated threats to close the Strait of Hormuz if attacked – a move that could strand about 40 per cent of internationally traded crude in Gulf waters.

“Enemies know that we are easily able to block the Strait of ­Hormuz for an unlimited period,” said the ­Iranian Revolutionary Guard ­commander, Mohammad Ali Jafari.
GCC states have begun planning oil-export routes that would bypass the Gulf. Abu Dhabi’s International Petroleum Investment Company said its project to build an oil export pipeline to Fujairah’s coast on the Gulf of Oman would ensure “reliable” crude exports to the world.

The US government, also fixated on oil-supply concerns, led a chorus of energy consumers pleading with Opec to boost output. In June, Australia, a net oil exporter, paradoxically joined the choir when its prime minister, Kevin Rudd, urged G8 leaders preparing to meet in Japan to “apply the blowtorch” to Opec.

At first, Opec argued forcefully that the world was adequately supplied with crude. But between May and July, Saudi Arabia pumped up its output by 500,000 barrels per day (bpd).

No sooner had the kingdom opened its oil taps than the market switched its focus from supply to demand. By July, demand for oil products had clearly started to shrink in the US and Europe, as the developed world’s car owners responded to record petrol prices by driving less and in more fuel-efficient vehicles.

With startling speed, the oil market did a U-turn. Prices entered free fall as oil stocks built. Supply was no longer the issue, and events that would otherwise have rallied oil prices failed to do so.

In August, Russia waged a short war with Georgia, disrupting the flow of Central Asian crude to Black Sea and Mediterranean ports. In September and October, two devastating hurricanes shut down Gulf of Mexico oil-producing platforms and refineries on the US coast of the Gulf. The price slide continued.

Last month, the hijacking of a Saudi Arabian supertanker off the coast of Kenya moved oil prices upwards – for three hours.

Even Opec, which aimed to cut 2 million bdp of supply from the international market in October and ­September and followed up with a record 2.2m bpd quota reduction this week, could not halt what became the steepest sustained oil-price ­decline in history.
The only notable interruption to the five-month descent was a record one-day spike on Sept 22, when crude jumped by more than $16 a barrel after the US government unveiled a $700bn economic rescue plan. But oil quickly dropped the next day on well-founded fears that the stimulus package would be insufficient to prevent the world’s biggest economy from stumbling. Indeed, most of the world’s major economies, including the US, Japan and the euro zone, are now officially in recession.
In the first week of this month, following news of massive US job losses and an Opec decision to delay a ­further production cut, crude posted a record 25 per cent single-week drop, falling to a four-year low just above $40 a barrel.

Following Opec’s latest decision, announced on Wednesday, to cut output more than expected, a modest week-long rally turned into a rout, with crude trading on the New York ­Mercantile Exchange for as little as $33.44 a barrel on Friday.

Many analysts said crude still had further to fall, as investors focused on evidence that stocks of unneeded oil were continuing to swell. On the economic front, the extent to which the previously robust economies of China and India would weaken due to falling global demand for manufactured goods remained a pivotal concern, sparking forecasts of oil demand contraction both this year and next.

On the surface, next year’s ­prognosis for Gulf oil producers looks grim. Crude prices are already below the fiscal break-even points for most GCC countries, including the region’s biggest economy, Saudi Arabia. Big refining and oil production projects face delays. And a host of other economic problems are emerging in the region, from falling property prices to ­mounting job losses.

Still, a period of more staid economic growth could also provide a welcome respite for relatively well-financed Gulf states to address basic infrastructure problems.
Chief among these is the need for more power and water capacity.
The UAE acknowledged the magnitude of its growing electricity problem in April, when the Government unveiled a policy platform for the GCC’s first civilian nuclear power programme.

Around the Gulf, states have scrambled to find and develop gas reserves, or to import gas for power generation. Some have considered coal-fired projects.

In the meantime, the still unanswered question for both oil producers and consumers is whether the sharply lower prices seen in the fading months of this year will linger next year and beyond.
There are sharply divergent views.

The International Energy Agency and many economists argue the credit crunch and low crude prices will slow investment in oil development, setting the stage for supply concerns to resurface and prices to roar back. The World Bank, among others, sees the rapid fall in demand for oil and other commodities leaving plenty of spare production capacity that may not be absorbed for years.

To an unprecedented extent, the Gulf region’s future depends on which of these scenarios plays out. A return to strong crude prices would mean a healthy future for the ­region’s key oil sector and its new clean energy ventures. An extended period of depressed oil prices would spell an economic reversal that could wipe out the previous years’ advances.

And so far, GCC governments have given few indications that they have decided for which case to prepare.

tcarlisle@thenational.ae