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News // Oil and gas worldwide

Crude Oil could drop to $50

03 October 2008 , 12:51Jo Amey816
Merrill Lynch & Co. have warned that crude futures could fall below $50 US in the event of a massive global recession.

On Thursday, the investment bank, itself a victim of the credit disaster shadowing American markets, slashed its 2009 oil forecast to $90 saying prices could fall harder and faster if the troubles spill out beyond the U.S. into the broader world economy.

Oil pries have averaged $113.24 so far in 2008, compared with $72.36 for all of 2007.

The financial crisis has harshly intensified showing clear signs of spreading outside the United States. A plunge in leading indicators in the U.S, Europe and parts of Asia suggests that the global economy is weakening significantly faster than expected," the report said.

Benchmark oil prices fell about five per cent Thursday, losing $4.56 to close at $93.97 in New York. Futures are down more than $50 since reaching a peak of $147 in July.

Merrill Lynch noted U.S. demand will fall about seven per cent this year, the fastest rate since the oil price shocks of the 1970s and '80s.

In Calgary, economists said the depth of a global recession depends on the outcome of the U.S. government's proposed $700-billion US bailout, which goes in front of American lawmakers Friday after being soundly defeated earlier this week.

According to Philip Verleger, a world-renowned oil expert who has advised several U.S. presidents on oil policy, the Congress has no choice but to pass the bailout to avoid a deep and painful economic contraction.

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."

Speaking from Colorado -- where he is in the process of moving to Calgary to assume a role at the Haskayne School of Business -- Verleger said tightening credit markets would affect the subcontractors of oilsands developers that perform the construction work more than the producers themselves. That in turn could exacerbate an already tight market for materials and services, driving costs higher even as commodity prices fall.

"I'm certain that many of the subcontractors are already in dire straits, even if the producers come out of this OK," he said in an interview. "These are serious adverse impacts to come out of the credit crisis."

With oil prices brushing up against the marginal cost of supply -- estimated to be $80-$90 a barrel in the oilsands -- Verleger said the Canadian and provincial governments have to come up with a mechanism to allow big new megaprojects to proceed through periods of low prices to avoid shut-ins and delays.

Deferring or delaying spending to develop new reserves will only result in even higher oil prices in the future, he noted.

"There's a real need to sit down and build a system of supports for these projects to continue through thick and thin," he said.

"The problem is that the periodicity of the oil price is longer than the periodicity of the investment cycle. There has to be some mechanism so these cash flows are more stable."

But others questioned what they see as a panic mentality gripping the market.

Frank Atkins, an economist at the University of Calgary, doubted that oil prices would fall to $50 without a major global depression that he says just isn't in the cards.

"In this volatile environment, anything could happen. But I attach a very low probability to that (a depression)," he said.

Atkins said the Canadian economy remains healthy despite the troubles in the nation's largest trading partner and biggest customer for Alberta's oil. He noted the Canadian banking sector is strong and the housing market remains on an even keel compared to the wave of foreclosures south of the border.

"We are going through our version of a housing slowdown, but you could hardly call it a 'crunch.' It's more like a price adjustment. Balance sheets on the financial side in Canada are a lot better than the States. I'm not wearing rose-coloured glasses, but I just don't see it happening here."

In a research note, commodities analyst Martin King was sanguine after lowering his own forecast numbers. "It's always darkest before the dawn, every cloud has a silver lining, and other ridiculous allegedly uplifting statements come to mind . . . when it is this dark before the dawn, groping around in the dark is not much fun."

Earlier this week, First Energy lowered its 2008 forecast to $111.50 and $115 in 2009 and 2010.

In his report, King argued that demand numbers are being skewed by one-time factors including the credit crisis.

"No doubt that demand is definitely down, but lower prices and some settling of the credit crisis waters (we hope), should help to generate some bounce back for U.S. petroleum demand," he noted. "Sunrise is still a few hours away, but at least we have a reading light."

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