October 2, 2008

Crude headed for a crash?

U of C economists say U.S. banking crisis could send oil plummeting

Washington’s ongoing hand-wringing over a potential $700 billion bailout for the teetering financial sector could have serious ramifications north of the border, particularly in the energy sector, according to several top University of Calgary economists.

Philip Verleger, a world-renowned expert on oil markets at the Haskayne School of Business, predicts that the price of oil could go into a free-fall if the banking crisis tips the U.S. in to a serious recession.

“When the price of oil drops, people start shutting in reserves. But they don’t shut in immediately. And unless OPEC cuts production, it could go to significantly lower.”

“It could go well below $50 per barrel.”

Verleger says if U.S. legislators fail to resolve the financial crisis, there will likely be more bank failures and a freezing of credit markets and investment.

“And that’s the prescription for a really ugly recession of at least two to three quarters.”

Bob Schulz, academic director for the Petroleum Land Management program at the Haskayne School of Business, agrees that oil and gas markets could go sharply downward if economic turmoil in the U.S. persists or gets worse.

He says the key will be whether troubles in the U.S. lead to a world-wide recession and spreads to the burgeoning markets of China and India.

“If there’s a domino affect from the U.S. economy to the Chinese and Indian economy, then that would reduce demand and likely cause a drop in the price of oil, probably down to about $70 per barrel.”

At that price, many of the new oilsands projects slated for the oilsands region of northeastern Alberta would become marginally profitable.

“That would be a number that they could tolerate for a little while but the longer term trend would have to be upwards.”

But Schulz says it’s still possible that oil prices could still rise -- particularly if the U.S. credit situation gets resolved reasonably, or if Venezuela opts to stop selling oil to the U.S. in favour of China.

Frank Atkins, a macroeconomics professor at the U of C’s economics department, says there’s so much anticipation of the U.S. Congress passing the White House-endorsed $700-billion U.S. bailout package that the question of whether it should be passed almost becomes a moot point.

“If you think about what they’re doing, they’re looking at financial markets and saying `you guys made a lot of really bad mistakes here. This package is going to buy your bad debt and bail you out.’”

“That’s not how we want an economy to operate. We don’t want to reward people for very bad decisions. So an argument could be made that the bailout package is the wrong idea and not something they should be doing.”

Atkins says even if the bailout package passes in the next few days, it’s hard to predict whether or not it will have the desired effect.

“The problem that we’re facing right now is that a doom and gloom mentality has taken over completely. A lot of people are grasping on to the worst-case scenario that’s even espoused by the President of the United States.”

“The U.S. economy, the best you can say, is they’re not going to come out of this really quickly. It’s quite possible that they could avoid recession but just be mired in very slow growth for a long period of time.”