Sunday, October 25, 2009

Expert: $80/Barrel Oil Could Re-Trigger Recession

Steven Kopits runs the New York office of Douglas-Westwood, an independent energy analysis company.

Kopits has written a new paper on Peak Oil and the economy.

In it, he notes that the worldwide oil supply of has not improved much since the 4th quarter of 2004. Yet, demand has continued to rise.

“And I don’t see anything on the horizon that makes it appear that we’re going to break out into a really new level of production that’s far different than what we have today. So if we’re talking about practical Peak Oil, my view is that it started in late 2004.”

Kopits says that China’s rapid growth will make it difficult for supply to keep up with demand, even if supply somehow manages to grow. But an increasing supply doesn't seem likely.

The International Energy Agency has pointed out that the decline rate appears to have increased to 6-7%.

But the most pressing issue at present is that rising oil prices could worsen the US recession.

This is a concern that Kopits shares with many economists.

“The US has experienced six recessions since 1972. At least five of these were associated with oil prices. In every case, when oil consumption in the US reached 4% percent of GDP, the US went into recession. Right now, 4% of GDP is $80 oil. So that’s my current view: If the oil price exceeds $80, then expect the US to fall back into recession.”

Right now, oil is already trading at over $80 per barrel, its highest level this year. Given Kopits’ analysis, that’s reason for genuine concern.

It requires great optimism to believe the US is currently coming out of recession. So that precludes the possibility of “falling back” into one. But, clearly, things can get worse.

Americans have cut oil consumption in response to the recession. The Federal Highway Administration reported that, as of September, Americans had traveled up to 112 billion fewer miles in the previous 13 months.

Yet, the price of oil continues to rise. In fact, prices have surged 25 percent in less than a month.

The plunging US dollar is largely to blame. Oil is traded in dollars, which are dropping in value. That makes oil more expensive in the US.

But rising demand in the developing world, particularly China, is also creating inflationary pressure on oil.

Kopits expects Chinese demand for oil to eventually stabilize at about 50 million barrels per day around 2032-2035. That's more than twice what the US – the world's biggest consumer of oil – currently uses.

But where will all that oil come from?

"If you have a flat—or heaven help us, declining—supply of oil, then the emerging and fast-growing economies will have no choice but to start bidding away the oil from the advanced or slow-growing economies. That is consistent with what we’ve seen in the data starting in about 2006. For China to grow, it will have to take away the oil of Japan, the US and Europe, just as it has in the last three years.

"If I run out the projections, this implies that US consumption is likely to drop by about one-third, from its peak at 21 mb/day before the recession, to about 14 mb/day in 2030. That will potentially be a long and painful adjustment.”

That's a stunning projection. It implies no growth in the US economy over the next two decades, but instead a massive contraction.

According to Kopits, the global economy cannot sustain oil at any price.

“Beyond a certain threshold, the result is likely to be stagflation or recession rather than perpetually increasing oil prices.”

Kopits says that we are in the midst of the first Peak Oil recession. The implications of that reality will be burdensome.

At a minimum, Kopits and other analysts believe that $4 a gallon gas is on the horizon.

Between a declining dollar and increasing Chinese energy demands, the American economy will be additionally impacted by the rising cost of oil.

The fact that it is a finite resource will become abundantly, and uncomfortably, clear.

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