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From boom to glut

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Published: October 23 2008 19:37 | Last updated: October 23 2008 19:37

The slide in world oil prices from July’s record high of $147 a barrel to less than $70 has been even more dramatic than their earlier rise. When the Opec oil cartel meets on Friday to discuss an emergency cut in output, its decision may do little to reverse that fall. A looming recession in the US and parts of Europe has knocked the widely held belief that the world is heading for a supply crunch. Temporary over-capacity is a more credible scenario.

It is hard to see the cartel not cutting production. Official US data show crude stocks rising faster than expected, evidence that consumers are reducing their energy use. The price of benchmark US crude could easily fall to $60 before stabilising.

Even the prospect of a large cut in output is priced into the markets. Analysts believe Opec would have to slash production by more than 1m barrels a day, and maintain a discipline it has repeatedly failed to show in the past, to avoid further price slides. There are hints that Saudi Arabia, Opec’s biggest producer and a moderating influence on its hawkish members, would like to see a smaller cut than that.

For central banks, the steep fall in oil prices is one piece of welcome news. Upward pressure on inflation should subside, allowing them to continue cutting interest rates – an essential step if the world is to avoid a deep, prolonged recession.

If sustained, the lower price level will have further repercussions. Big producers such as Russia and Venezuela will struggle to exert political influence through energy policy. Resource nationalism, where oil-rich governments impose tougher terms on independent companies and – notably in the case of Shell in Russia – force them to cede control of assets, may soon be a spent force.

National oil companies whose revenues finance their governments’ spending will find investment in new fields less affordable. They could end up turning back to the expertise of the independent majors to tap hard-to-access reserves. Western companies that need prices just shy of $90 to develop Canadian oil sands may have to rethink, too.

Even if new projects are delayed or abandoned, reduced levels of capital expenditure are unlikely to support oil prices. Enough crude is forecast to come onstream to keep the world adequately supplied over the next three to five years. Despite resilient Asian demand, world consumption may not grow at all in 2009. Overcapacity can be expected to weigh on the market. The question is what happens when the world gets back on its feet. Right now, that looks a distant prospect.

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