By Ryan McGreal
Published October 04, 2006
The popular consensus on why oil prices are falling right now boil down to some combination of the following factors:
In other words, the rise and fall is a run-of-the-mill price cycle, albeit at a much higher base price than six years ago.
This was certainly my interpretation until I read an intriguing article in the Telegraph (UK), which argues that the drop is actually in response to market fears of a looming US recession.
Hedge funds and oil traders are selling their crude holdings because of fears that the US economy could slump next year, dragged down by the stalling housing market. Figures released yesterday showed US house prices falling last month for the first time in over a decade, while the inventory of unsold houses was at its highest level for 13 years. Traders are concerned that an American slowdown would drag many other major oil importers down, causing worldwide energy demand to plunge.
High energy prices squeeze the economy and push up inflation, provoking central banks to raise interest rates, which further slows the economy, particularly in the US, where the housing bubble, dependent on low interest rates, is pretty much the only thing that kept many people afloat the past few years.
The burgeoning economies of China and India, which have generated much of the growth in demand for oil over the past several years, would be affected as well, since much of their economic activity is producing cheap goods for export to the US. The result could be a slow-motion collapse in global demand for oil as the US drags the global economy into a recession.
Taking this thesis and running with it, Dave Cohen at The Oil Drum has written a very detailed essay on how and why this might happen.
Cohen believes three converging phenomena - the negative yield curve, the housing bubble, and the oil price shocks model - are enough to warrant serious concern about a looming downturn. The three phenomena are complex, but Cohen does a good job of explaining them.Despite the fact that the recession will actually result in falling oil prices, Cohen explains why it makes sense to analyze this in the context of the peak oil hypothesis:
For those concerned about peak oil, low prices resulting from decreased demand in a recession has two detrimental effects.
- Development of new oil & natural gas projects that now depend on high prices is curtailed.
- Development of substitutes for oil & natural gas is curtailed.
Lower—maybe much lower—demand over a significant period of time (a few years) masks the global production peak but does not help solve it. When the global economy does finally emerge from a recession, the same old problems will still be with us but mitigation efforts will have been crippled. Furthermore, most people will be persuaded that the peak was a fiction due to the low prices they have just seen during the recession. In the meantime, however, the world will still have been consuming oil—large amounts of it—thus draining existing production but without developing new supply as the low prices put many projects on hold. [emphasis in original]
Unfortunately, by assuming market forces and price signals will magically balance supply and demand, peak-oil-denying economists are performing a grave disservice. They fail to recognize that the market will accomplish this goal through an increasingly volatile economic cycle as high prices destroy demand in recessions, and the recessions then spur rapid but temporary growth after the price collapse restore pent-up demand.
We're going to be so busy riding the shock waves of an economy that's addicted to oil but can't grow past the global production limit that we won't have the time or the resources to plan properly for a post-oil economy.
In the meantime, as each run-up in oil prices breaks against the latest recession, the cornucopian economists will keep congratulating themselves and saying, "I told you so," even as the total wealth we have to invest gets ratcheted down bit by agonizing bit.