Growing uncertainty about demand and supply requires Opec to find a
more flexible way of managing the oil market.
Nobody has any idea about what is going to happen next. World financial markets have seized up and politicians are struggling to find a way to make them work again. The economy is “on the cusp of a global recession”, according to IMF managing director Dominique Strauss-Kahn. The commodity boom is over, for now.
Some Opec members are calling for output cuts to defend oil prices. Opec is right to be afraid. Demand is falling for the first time since the first quarter of 2002, as stocks are run down to release cash and economies slide towards recession. Global oil demand was lower in the third quarter than in the same period last year despite continued strong growth in non- OECD countries, because OECD oil use fell by 1.7mn b/d, according to Argus estimates. Non-OECD demand growth exceeded the fall in OECD demand earlier this year, but this trend will not re-establish itself if the worst fears about the global economy are realised.
Next year is particularly uncertain. The IMF’s latest World Economic Outlook sees the global economy slowing abruptly to 3pc growth next year from 5pc last year as OECD countries go into recession. But non-OECD economies are expected to remain more robust, slowing to 6pc growth next year from 8pc last year. On this basis, global oil demand growth next year could be similar to this year, with higher non-OECD demand just offsetting lower OECD demand. But this forecast may be overly optimistic. If China, India and the Middle East were to lose their thirst for oil, global demand could fall sharply.
With oil demand and the global economy teetering on the brink of collapse, defending high oil prices is the last thing Opec should be considering. Prices have nearly halved from this summer’s peak, but they are still extremely high in real inflation-adjusted terms and no lower than they were a year ago. Now that the demand-driven boom of the past five years has been halted, oil and other primary commodity prices need to fall so that the global economy can recover quickly.
But oil prices are unlikely to collapse. Non-Opec supply is not a threat, as investment costs are high and companies are struggling to sustain production. Opec’s forecasts of sharply rising non-Opec output are wide of the mark. Non-Opec production this year is expected to fall by about 200,000 b/d following the recent disruptions to US Gulf of Mexico and Azeri output. Non-Opec supply growth next year is unlikely to exceed 400,000 b/d, according to Argus forecasts, and may turn out to be less if lower oil prices delay projects or further disruptions occur.
If the global economy is to avoid recession, oil prices must play their part, letting the market establish a level that is affordable rather than prohibitive. Opec’s output cuts over the past year — combined with excess demand and downstream refinery constraints — helped drive oil prices to unsustainable levels. Now Opec needs to agree a more flexible way to manage the market. Given the huge uncertainties about demand and supply next year, the organisation should recognise Saudi Arabia’s role as the only exporter with the flexibility to balance the world oil market. Changing historical output quotas is not an effective policy.
