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Fear of economic slowdown hits oil price

By Mohamad Al Kady



After hitting the $100 per barrel mark by the beginning of the year, oil prices lowered to below $90 a barrel due to several factors, especially deepening fears that a world economy slowdown could curb energy demand.

Reports showing a slowdown in US and Japanese economies and predictions that the fast-growing Chinese economy might have peaked, added to fears of a recession in the world economy. The negative economic sentiment has been the oil markets’ driver in recent days, pushing prices down nearly $10 during the past two weeks.

Concerns about the economy were ignited by a US Commerce Department report last week that construction of new homes fell by 25 per cent in 2007, the largest drop in 27 years.

Also there is doubt among investors about the effectiveness of the proposed tax cuts in the United States in arresting the downward slide of the US economy.

But oil experts see other factors in the current decline in oil prices. “The world economy is still strong. The slowdown happens in the growth rates, not in the whole economy. The main factor behind drop in oil prices is the retreat of geopolitical pressures. The US toned down its threats to Iran during the last two weeks,” Ali Al Baghli, former Kuwaiti oil minister, told Emirates Business.

He said the GCC tour by US President George Bush failed to gear up a regional front against Iran. “This situation eased worries about safety of oil supplies from the region, and this eased pressures on oil markets and led to the decline in prices.”

Forecasts about oil demand also added to the worries. The International Energy Agency (IEA) cut growth predictions for world oil demand this year to 2.3 per cent from a previous estimate of 2.5 per cent.

The IEA said global oil demand will rise to 87.8 million barrels per day this year, and added that it could revise its forecast again if the US economy worsens.

But some oil experts say the decline in oil prices has been contained by expectations the US Federal Reserve will cut interest rates in coming months to avert the economic downturn.

Fast growing economies like China and India have been consuming oil at high rates, which has reduced the relative weight of the US market, even if the US remains the world’s largest consumer of oil.

Al Baghli said previous forecasts depended on the fast growing demand by China and India, but both countries reached a high level of demand and this will continue over the coming years. “Economic growth rates in developing countries reached high levels, so the current slowdown does not reflect a recession. The demand from China and India, for example, did not increase during the last month but their oil demand will continue at top levels for the next couple of years,” he said.

Oil markets will continue monitor the world economy in coming weeks. Prices could decline as more evidence emerges of an economic downturn in the US, Europe and Asia.

Experts said that the global oil market will see softer demand starting next month because peak winter demand would have passed and demand is typically weaker in the spring.

But Al Baghli accused traders and brokers in oil markets of the unjustified increase in oil prices during 2007. “The on spot and daily trading of oil in international markets reached 85 million barrels per day, while future oil deals reached 1.5 billion barrels per day. Brokers play a major role in increasing prices of future deals.”

He explained that trading in future oil contracts depends on psychological factors, speculations and fears of geopolitical developments, so the hike in oil prices always happened in future prices.

Traders are also looking to a February 1 meeting of the Organisation of the Petroleum Exporting Countries (Opec) in Vienna. Some top officials in Opec countries already disclosed that there is no reason for the cartel to hike production.

Opec countries blamed the rising prices on oil speculators rather than tight supply. They said that the decision to boost production by 500,000 barrels per day last September did not counter rising prices.

Surplus world oil capacity has declined since 2001. Current surplus capacity reached more than 1.6 million barrels a day, down from more than five million barrels a day in 2001.

A recent study by Boston-based Cambridge Energy Research Associates said while output from the world’s existing oil fields is declining at a rate of about 4.5 per cent annually, new projects in the works will make up for the decline. This study supports a view that there is no impending short-term peak in global oil production.

But the UK-based Oil Depletion Analysis Centre said in a report that peak production had already been observed in 60 of the world’s 98 oil producing countries.

Al Baghli said most oil producing countries are benefiting from the high oil prices, so they are producing at full capacity. “We see a surplus in production capacity in a few countries, mainly Saudi Arabia the UAE and Kuwait. These countries already enjoy a surplus in their budgets and financial liquidity, so they are not interested in increasing their production in the short term,” he said.

Al Baghli added that increasing output capacity also needs large investment funds and long-term projects. “So we can see expansion in supply capacity on the long term as long as oil prices with continue in high levels.”