The collapse of the big oil bubble may not last

04 November 2008

Though global economic conditions are at their worst in many decades, oil prices are still higher than they were during any of the previous recessions. That may signal the possibility of yet another price surge when the global economy recovers. By Shivshanker Verma

Arjun Murti must be a very lonely man now. The 39-year old head of energy research at Goldman Sachs was the best known oil analyst until recently. Soothsayer, clairvoyant, Mr Crude Oil monikers for the man who first predicted a 'super-spike' in energy prices and crude oil prices going past $100 per barrel were many. The world watched in disbelief when his prediction came true, dubbing the Oil Oracle of Goldman Sachs.

When oil prices continued to surge, well past the first target, Murti raised the target to $200 per barrel. When he made that call in May this year, it seemed only a matter of time before that target was taken out. Oil prices were rising uncontrollably and politicians were scampering to find a way to ease the burden. Most of them blamed speculators and alternate fuel research was all the rage, matching the crazy days of the internet boom.

Then came the crash. After touching an all-time high of $147 per barrel, oil prices have dropped more than 50 per cent within a few months. Even Murti was forced to retreat. He cut his forecast for 2009 oil prices, first to $110 per barrel and more recently to $75 per barrel. His worst-case scenario for next year is just $50 per barrel, a far cry from his earlier bullish predictions.

No wonder, those who hailed him earlier were quick to dump him as yet another fallen prophet.

But, were the basic premises behind Murti's forecasts all that wrong? True, his price forecasts have been proved spectacularly wrong. That is mostly because the world is going through the worst financial crisis in living memory, something which very few anticipated. Murti himself acknowledges that. The latest report from Goldman Sachs says they underestimated the dramatic demand decline because of the global growth slowdown.

For now, it is all about demand
When oil prices were surging, the focus was more on supplies. Though higher demand from emerging countries was touted as the main reason behind higher prices, the incremental growth in demand was nothing spectacular and it was not that the world was facing any physical shortages. All it did was to reduce the supply buffer and, along with a shortage of refining capacity, made oil prices highly sensitive to even minor supply disruptions. The longer term story was that, if the demand growth continues even at a modest pace, the world will eventually run out of oil and there are no alternative energy sources in place.