Oil prices will begin to ease from fourth quarter of this year as the market will witness substantial increase in spare capacity, according to a forecast by a US think-tank.

Global Insight, the world's leading company for economic and financial analysis and forecasting, said crude prices will drop as the supply and demand projections indicate that the world is set to see a significant increase in spare capacity over the next six to 18 months, following a string of new projects entering production.

"New supply was always going to be heavily weighted to the second half of the year, and delays to several projects have pushed back a number of developments due in the first half of 2008. This has meant a tighter-than-expected first half, contributing to a very sharp increase in prices. But this also means a significant amount of capacity will be added to supply in the second half of 2008," the think-tank said in its Outlook for light vehicle sales under a high oil price scenario report.

It is predicted the Organisation of Economic Co-operation Development (OECD) demand is also likely to remain weak due to a combination of consumer behaviour [in response to higher prices] and a faltering economy. "Although we do still expect to see relatively strong growth in non-OECD economies. Even here there are downside risks present and it is possible that weaker OECD growth will have an impact on developing economies in the second half of 2009.

"There are signs many of these economies are close to over-heating, given the rising inflation. These risks are compounded by the downturn in the non-OECD's key export markets. Nevertheless, even with these risks to the forecast, we do expect non-OECD demand growth to offset declines in the OECD; but because of the surge in supply, there will be enough oil available to more than adequately meet demand," it said.

The timing of both supply and demand growth in 2008 has helped shape a year that is showing two distinct phases. The first half of the year has seen a tightening market.

Demand growth from non-OECD countries continued to grow at broadly the same pace it had in 2007. At the same time, new project start-ups were limited, and many delayed until the second half, or in some cases pushed back into 2009.

Global Insight said a global surge in middle distillate demand highlighted current capacity constraints in the refining complex and also boosted demand from marginal refineries for distillate-rich crudes.

Because petrol, naphtha and fuel oil margins remained extremely low [and in some cases negative], this created an unbalanced market for particular crude streams. Middle Eastern producers refused to discount heavier grades to encourage purchases. And this meant some oil was essentially kept out of the market as a result of pricing issues.

"Iran's chartering of 14 large crude carriers to hold crude Iran could not find buyers for is the best example of this. A tight situation became tighter due to aggressive pricing policies and constraints in the refining sector," the report said.

Global Insights expects the high prices seen in the first half of 2008 to ease significantly. "Our base case forecast reflects an improving balance; but is also conservative as the volatility seen over the past six to 12 months could result in a rebound in the market if capital inflows into commodities pick up again, or the dollar weakens. The fundamentals do point towards a surplus of crude oil and the tightness in the refining sector should begin to ease. Opec may take action to halt any signs of price weakness through precipitous output cuts and this will limit the extent of any price fall."

High oil price scenario ($150–$200)

Despite sound arguments against 'peak' oil, there is quite a bit of controversy surrounding not only how high the price of oil might climb, but also the long-term direction of oil prices, up or down.

Thus, Global Insight has prepared an alternative forecast of the WTI price and consequent projections of light-vehicle sales in the US and major Asian markets, and for West European passenger car sales, building upon the current base case [which anticipates continued high oil prices] and subsequent years of 'peak' oil.

The report said the price of oil increases faster than the base case for 2008 and 2009, reflecting either a faster-than-expected deterioration in non-Opec supply and/or a production disruption from a major producer.

Subsequently, the perfect storm is generated, where all negative factors come together:

- Severe supply constraints

- Financial and speculative issues continue to remain in force

- Demand from emerging markets continues strong for some time after the United States downturn

- Market psychology supports peak oil, despite sound fundamentals pointing to the contrary

This drives the average for the WTI from just under $150 per barrel in 2009 to average a $160 in 2010 and eventually $195 by 2012.

Global Insight said the price will stay there through 2015 and retreat only slowly over the next few years.

This initially triggers a deeper recession in the US and other developed economies. Eventually, the emerging markets join in a global recession. While it is difficult to put a probability on this type of scenario, it could be as high as 25-30 per cent.

The US situation is more problematic due to the still relatively weak dollar, penchant for cheap petrol and preponderance of big trucks has aggravated the impact of soaring oil prices.

Europe is somewhat insulated by the strong euro, earlier adaptation to higher gasoline prices, stricter emission standards, and a better mix of small cars and diesel engines. Asia is more complex, because of the wide diversity of its markets in terms of stage of economic development, motorisation stage, vehicle demand dynamics, fuel subsidies and taxes, just to mention a few factors.

United States

The combination of high oil and the sub-prime mortgage/credit crisis has pushed the US economy to the recession point. A move up to $200 per barrel would abort the recovery and trigger a deeper recession.

With the current base case forecast, light-vehicle sales has really take a pounding this year and next, falling from 16.1 million units in 2007 to roughly 14m in both 2008 and 2009. As the price of oil moderates only to $120 per barrel, light-vehicle sales improve modestly to 15m units in 2010 and 15.8m by 2011. The report said as oil prices are higher, the market falls to 13.9m units this year and declines further in 2009 to 13.800m units.

Since the market remains well below 15m units for four years (2008–'11), considerable pent-up demand is generated. This mutes somewhat the negative impact on light-vehicle sales of the close to $200 price tag for oil reached by 2012. Under this scenario, sales will rise slowly in 2012 and 2013 to 15.747m and 16.356m units. This is still almost 800,000 units less than the base case in 2012 and a half-a-million in 2013. Outbound, the economy and market will adjust to living with drastically higher oil. From a market perspective, the mix of vehicles will change dramatically.

Diesels, hybrids, new technologies and lighter materials will abound. This pushes volume to 17.3m by 2015 versus 17.750m in the base case forecast.

Western Europe

Europe still continues to be partly insulated from the full impact of the surge in oil prices. The combination of strength of the euro and the high excise taxes in Europe means the percentage increase in fuel pump prices has been only a fraction of the hike in world oil prices. In addition, a smaller more fuel-efficient fleet of cars and lower annual distances travelled by European drivers mean Europeans have been saved from the savage increase in direct running costs seen elsewhere.

All this means the European market has been largely insensitive to high and climbing oil prices, at least until early this year. This is now being tested under both our new base case forecast for oil and notably under more extreme oil price scenarios.

In both May and June 2008, European car markets tipped downwards and the decline accelerated in July, as consumers have come under sustained pressure on their household budgets.

The new base case forecast for oil amplifies the problems associated with slowing global and Eurozone economies, higher inflationary pressures, credit restrictions and the bursting of housing bubbles. This means new car sales will, in all likelihood, slip substantially below 14m units in 2009, for the first time since the mid-1990s. The car market would then virtually stagnate, failing to recover back above the 14m unit threshold, until 2013.

Asia

Surging oil demand from Asia, especially China and India, is often cited as a major factor behind the surge in world oil prices. Will higher oil prices curb vehicle and energy demand in this region, or will subsidised fuel prices continue to support strong demand growth and put further upward pressure on world oil prices?

There is now little doubt that a global slowdown or a recession will hit Asia's export-dependent economies and will trigger significant slowdown in the domestic economies. Inflation is a huge concern and monetary tightening to control it is exacerbating the impact on consumer spending and vehicle demand. It is also becoming clear that the state of public finances in virtually every country in Asia, apart from China, means the high levels of fuel price subsidies are not sustainable. These broad subsidies are being reduced in stages, resulting in controlled increases in fuel prices. The good news is that economic growth in the region will moderate from very high levels rather than grind to a halt, providing healthy fundamental support for vehicle demand.

Overall, for the entire Asia-Pacific region, light-vehicle demand is expected to rise from 19.7m units in 2007 to 28.4m units by 2013 in the base scenario. In the 'high oil price scenario', governments have the option of sheltering consumers from the full impact. Growth rates, however, will still moderate significantly, cutting the size of the total light-vehicle market by around 3.4m units to around 25.0m units in 2013.