Passing the fall seasonality which usually brings a strong surge in demand for heating oil, oil demand destruction will continue in winter and spring 2009 as a result of the downward spiral in income that has been brought about by the financial crisis. It is not surprising that US oil demand will reach between 17-18 mbd by the middle of 2009 and oil price will bounce in the range $50-$70 a barrel. There will also be a reduction in demand coming from the rest of the world. When all things put together, world oil demand may drop by four million barrels from its 86.5 mbd level in 2007. During this period, oil inventories will accumulate as oil producing countries will supply more than is demanded. OPECOPEC countries will end up losing more oil revenues than if they strategically waited until spring 2009 to initiate their production cuts.
This should intensify OPEC’s dilemma which is now chasing the oil price with its production cut axe in a way similar to chasing mirage in the desert. OPECOPEC has cut output by 1.5 mbd effective November 1, 2008. The market shrugged OPECOPEC action as insufficient and deemed it ineffective. This Organization has now positioned itself for further cuts in December 2008 and in March 2009. OPECOPEC will have to cut output by at least one mbd in December and match this cut in March 2009. Can OPECOPEC follow this sequence without suffering a disproportionate decline in oil revenues which it tries to maximize by its crusade of cutting production? Another complementary question is: Can OPECOPEC abide by this sequence of cuts? The answer is most likely no. The result is that oil price will reach $50 a barrel before the middle of 2009 because of the stubborn imbalance between supply and demand despite the cuts. The US dollar, the safe haven currency during crises, will not stand down to help the oil price go up during this period.
What is our expectation in the second half of 2009? Oil price would receive help not from the dollar but from the US equity markets during this period. Oil price should chase equity prices during this period which is a role reversal for oil. Being naturally forward looking, the US stock markets will stage a prolonged and authentic rally six to nine months before economic recovery sets in around the middle of 2009. The economy would receive help from the next administration and Congress as a new fiscal rescue will be enacted. The new fiscal package should include extension of unemployment compensations as more workers will be unemployed, a tax rebate to put immediate cash in consumers’ pockets, legal changes in mortgage contracts for those facing foreclosures and infrastructure renovations. This new package should be substantially greater than the previous one which amounted to about $150 billion.
We are now living in a world where speed and not trickling down is the name of the game. Massive amounts of funds of different currencies aided by state of the art technology can cross borders in minutes and can be poured on risk assets. Prompt, timely and joint actions are nowadays are required to deal with mutations in the world economy. Speed applies not only to markets and businesses but also to government policies. In this speed, time is very important. This fact is now more understood by investors, business people and government officials than few months ago. Oil and stock markets will move faster than before and there is more dynamic and symmetry between them than before. It will not be long before oil price will challenge its old record and the stock markets will do the same.
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