The assumption of much higher prices is a very modern phenomenon, born of explosive emerging market demand. For the time being, this seems to be over.
The assumption of much higher prices is a very modern phenomenon, born of explosive emerging market demand. For the time being, this seems to be over. Photo: AFP
Revisiting the past year's predictions is, for most columnists a frequently humbling experience. The howlers tend to far outweigh the successes. Yet, for a change, I can genuinely claim to have got my main call for markets - that oil would sink to $US80 a barrel or less - spot on, and for the right reasons, too.
Just in case you think I'm making it up, this is what I said 12 months ago: "My big prediction is for $US80 oil, from which much of the rest of my outlook for the coming year flows. It's hard to overstate the significance of a much lower oil price - Brent at, say, $US80 a barrel, or perhaps lower still - yet this is a surprisingly likely prospect, the implications of which have been largely missed by mainstream economic forecasters."
If on to a good thing, you might as well stick with it; so for the coming year, I'm doubling up on this forecast. Far from bouncing back to the post crisis "normal" of something over $US100 a barrel, as many oil traders seem to expect, my view is that the oil price will remain low for a long time, sinking to perhaps as little as $US20 a barrel over the coming year before recovering a little.
I've used the word "normal" to describe $US100 oil, but in fact such prices are in historic terms something of an aberration. The long term, 20-year average is, in today's money (adjusting for inflation), more like $US60. It wasn't that long ago that the Organisation of the Petroleum Exporting Countries was targeting $US25 oil, which back then seemed a comparatively high price. Be that as it may, for 15 years prior to the turn of the century Brent traded at around the $US20 mark in nominal terms. Oil at $US20 is a much more "normal" price than $US100.
The assumption of much higher prices is in truth a very modern phenomenon, born of explosive emerging market demand. For the time being, this seems to be over. Chinese growth is slowing and becoming less energy intensive. By the by, however, the relatively high prices of the past 10 years have incentivised both a giant leap in supply - in the shape of American shale and other once marginal sources - and continued paring back of existing demand, as consumers, under additional pressure from environmental objectives, seek greater efficiency. Lots of new technologies have been developed to further these aims.
Personally, I wouldn't read much into the present deep "contango" in markets - an unusual alignment whereby futures prices are a lot higher than present spot prices. Some cite this as evidence that the price will shortly rebound. I'd say it's just a leftover from the old "peak oil" mindset of permanently high prices. When the future arrives, prices will still be low, confounding those who have bought forward.
In any case, for now we are faced with an oil glut, and there is no reason to believe that this mismatch between supply and demand is going to close any time soon. Assuming Saudi Arabia sticks to its new strategy of "let the market decide", and there is not some new seismic geopolitical disruption in supply, comparatively low prices are going to be with us for quite some while.
Prices will also need to sink a lot lower before they begin to recover if they are to close down today's more marginal sources of excess supply.
All this is extremely good news for Western economies, for which lower oil prices act like a fiscal stimulus. For some states in the US which have come to rely heavily on the shale boom, a painful period of adjustment lies ahead. But the net impact for the economy as a whole is going to be positive, further fuelling what already seems to be a self-sustaining American recovery. The first rise in US interest rates cannot now be far off.
The same is substantially true of the UK, where the benefits of lower oil prices outweigh the damage they will do to North Sea revenues and supply. It also ought to be the case in the eurozone, where lower oil prices are expected to turn the inflation rate negative over coming months.
These deflationary conditions would normally be seen as very negative for Europe's main economies. However, to the extent that they are caused by the supply-side shock of falling fuel prices, they are undoubtedly good news, providing a much-needed shot in the arm.
Unfortunately, they are also unlikely to make more than a marginal difference to a continent economically marooned by bad policy and an increasingly fractious political environment. The eurozone high command has spent the past four years imposing policies on its constituents that plainly haven't worked in restoring growth and stability.
Worse, these policies have come widely to be seen as a form of economic coercion quite alien to the European tradition of fiercely independent sovereign states. Eurocrats should not be surprised that the natives are starting to rebel. According to Einstein's famous definition, madness is repeatedly doing the same thing and expecting different outcomes.
Sure enough, there will eventually be a full-scale programme of quantitative easing from the European Central Bank, but in itself this is most unlikely to do the trick. Monetary policy can bring demand forward from the future, but it cannot address the underlying causes of Europe's sickness - dysfunctional monetary union. Politically, there is little or no appetite for the further integration that might help the single currency work a little bit better.
A push-me-pull-you year is in prospect - the oil price pushes in one direction, the eurozone in quite another.