Used to be if someone said “but this time it’s different,” adopting a contrarian view usually turned out to be the safest and most profitable. (Think internet stocks in early 2000 or Las Vegas real estate in 2006.) Wall Street’s time-tested maxim may finally have met its match in rising energy prices, however, for when it comes to $100-a-barrel oil, this time something is different.
What’s different this time, compared with 1973-1974, 1979-1981 and 1990-1991 when oil prices also spiked, is global demand. Unlike in the past 30 years when global oil prices surged on artificial supply constraints, then quickly fell when those constraints disappeared (as we remember all too well in 1980s Oklahoma), worldwide demand for petroleum products is surging in developing areas, principally India, Southeast Asia and China, while advancing steadily everywhere else including the U.S.
“Peak oil” describes the condition at which worldwide demand for petroleum products meets worldwide supply, based on known reserves and production capability, and an estimated equilibrium point, as one would expect, is controversial but now a subject of open debate. An obscure reference as recently as 2002, an internet search for “peak oil” now yields more than 10 million hits.
And recently peak oil has entered the mainstream media. Less than a month ago on prime-time TV, Dallas oilman T. Boone Pickens, who has been right more often than not in his career (predicting $100 oil earlier this year), observed worldwide demand now tops 88 million barrels per day (bpd), already exceeding current global supply, in his estimate, by 3 million bpd. Others, more optimistic, concede peak oil is a “when” not an ‘if.” The International Energy Agency recently warned that the price of oil would remain high for the foreseeable future because of supply shortages resulting from burgeoning demand in Asia.
Although IEA forecasts a 40 percent increase in global supply to 116 million bpd by 2030, some top oil company executives disagree. The CEOs of both ConocoPhilips and Total S.A. foresee future output barely enough to cover anticipated growth from China and India alone as "optimistic." Said James Mulva of ConocoPhilips at a financial conference last month, “I don't think we are going to see the supply going over 100 million barrels a day, and the reason is: Where is all that going to come from?"
To be sure, some of the recent jump in oil prices, now hovering under $100, is speculative froth, as ‘”fast money” is redirected into commodity investments, including foodstuffs and minerals. Some of the rise also is attributed to concerns about supply instability as tension ebbs and flows in the Middle East. It has been observed that $100 oil only equals the inflation-adjusted peak reached in 1981 and no lasting economic harm came from that period. Yet that fails to consider the subsequent collapse of global oil prices within a few years as major discoveries in Alaska and the North Sea resulted in a surge of supply.
What’s different this time? Increasing global demand is meeting naturally constrained supplies, and no new North Sea- or Alaska-like fields appear in the offing to make the last five years’ price appreciation a potentially temporary situation.
American consumers by now are fully immersed in a 2007 holiday shopping season that began in early November and January’s analysis of the season’s retail results along with Fourth Quarter 2007 corporate earnings will speak volumes about anticipated economic activity in the new year. A recent poll revealed nearly half of respondents already believe the U.S. economy is in recession, despite Third Quarter data to the contrary, but since perception often influences, or creates, reality, social mood will be a key driver of activity in 2008.
The Federal Reserve will see intense pressure from Wall Street and Main Street (in the form of political candidates) to continue rate-cutting. Despite weakness in the dollar already triggered by its first two cuts, the Fed may be compelled to cut again both in December and early 2008, based on increasingly credible estimates of $300 billion-to-$500 billion in total subprime-related write-offs, and its legitimate concern such staggering losses could impair not only U.S. but global finance.
“Flight-to-Quality” continues to drive down longer-term U.S. Treasury rates (10-30 year) and further weakening of the dollar against major currencies. Gains in U.S. exports, which benefit from a weaker dollar, may not be sufficient to offset a domestic decline in economic activity. At some point inflationary fears may drive long-term rates higher, notwithstanding Fed rate cuts.
A “soft landing” in 2008 followed by renewed economic growth remains well within the range of possible outcomes. Social mood and business results for 2007, including further fallout from the now-regionally-contained housing slump – only a year old in hindsight, and six months since officially pronounced – will set the economic tone for 2008, again distorted by an election-year lens in which candidates for all open offices will seek to emphasize economic data to their advantage.
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