PETER G. HALL
Vice-President and Chief Economist
oil prices seem to have become a fact of life. Many have grudgingly
advised that we had better get used to it, and move on. Analysis
repeatedly cites insatiable emerging market demand and limited
accessible supplies as key factors. Itís tough, if not impossible to
refute these arguments, but similar reasoning in the early 1970s led to
wacky forecasts. Are todayís triple-digit projections reasonable?
A strange fact of modern analysis is that familiarity can breed
complacency. If a price, or any other data point persists for awhile,
sometimes months, weeks, or even days, it seems to be quickly embraced
as the new reality, one of the family. Until the next shift, that is. A
quick update of the analysis, and we have yet another new reality. Over
the past 20 years or more, this has been repeated, both on upside and
downside movements for a variety of economic indicators.
Crude oil prices have shown that they can drift from fundamentals for
awhile and convince even seasoned, specialized analysts that the world
has indeed changed, redefining fundamental levels. Witness the price
plunge to $10 per barrel in late 1998, when respected analysts pondered
the industryís future when prices reached $5 per barrel. Laughable
now, but serious chatter then. Ten years later it was the polar
opposite: predictions of $200-plus oil and the end of globalisation.
What can we make of this? History shows that out-of-range prices
actually set in motion their own undoing. Simple demand and supply
fundamentals kick in, moving prices back toward reality. If prices are
too low, overconsumption creates supply pressures, driving prices up.
High prices undermine the economy, slowing aggregate demand, and prices
generally follow. Are these forces currently at work?
Apparently so. Recent triple-digit crude prices occurred in a context of
weak world demand, low confidence and inventories at 20-year highs.
Persistence and a pervasive belief in constrained long-run fundamentals
seemed to convince markets that pricing was reasonable, in spite of the
soft near-term conditions. In contrast, analysts are now acknowledging
that high prices have undermined economic momentum, and in response are
The International Energy Agency agrees. Its monthly report, released
last week, describes slower-than-expected growth of world oil demand,
citing the dual and related effects of high crude prices and weakened
global growth. True, prices were pushed higher by Mideast political
turmoil, which temporarily constrained supplies. But prices had been
riding higher in advance of the turmoil.
The nascent price plunge that has taken WTI crude to the $80 range
suggests an overdue reality-check. Excessive stranded liquidity in the
world market likely fed price increases for some time, creating a
sustained speculation that suggested to market watchers a new
fundamental level. The current disruption is a challenge to that notion.
It is possible that, while the broader market is likely overreacting to
various fears, oil markets are being jolted back to more reasonable
The bottom line? Now is a noisy time for markets, and it is difficult
for any analyst to sort out or define what is reasonable. But when the
present decibel count drops, donít be surprised if crude oil prices
settle at new, lower levels.
views expressed here are those of the author, and not necessarily of
Export Development Canada.