The Perspective For Oil Prices.

WTI crude oil at NYMEX is a paper oil in a financial market quite different from that of physical crude oil. Paper WTI could jump above $100/b or fall below $80 at any time in the coming months. This is because recession has begun to hit the US, by far the biggest oil market in the world, and oil

could be one of the main losers. But at $80, WTI would be well below its $109/b peak reached in late 1979 when that is measured in today's US dollars with inflation taken into account. Inflation has already hit the world, mainly in China and other emerging economies (EEs) which are exporting it to the rest of the globe. With the US - by far the largest economy as well as the largest debtor in the world - continuing to print more dollars, the inflationary spiral seems to be unstoppable, which means today's oil prices and money are way below what they could buy three decades ago.

This perspective dangerous. Wealth is migrating from the OECD world to the EEs at a rapid pace. The threats to the world's largest energy reservoir are getting increasingly worse (see ood1-IraqBinLadenSaudiOilJan21-08). Instability in the Middle East has become an integral part of the global economy and the danger zones in this are Iraq, Lebanon, the Gaza Strip and the Shi'ite theocracy of Iran (see news5-lb&GsyrVsGisrEgptJan28-08).

To show the worth of this moving wealth: state-owned PetroChina in November 2007 became the world's most valuable firm. But only 2.2% of the company was floated on the Shanghai Stock Exchange. Its valuation at more than $1,000 bn - double that of ExxonMobil - only reflected the bubble in Chinese stocks. Within a month, PetroChina had lost a third of its value (though this kept it worth more than Exxon). Still, that the world's most highly valued firm in early 2008 was Chinese had a symbolic punch. Four of the world's 10 most valuable firms in the world were Chinese (see down26Rev&ProspDec24-31-07). But the Chinese bubble is only growing with more US dollars being printed and spreading across the globe. This bubble will burst as soon as Beijing ends its peg to the US dollar, certainly not before the Olympics in August 2008.

Recession worries last week sparked sell-offs in financial markets around the world and the US Federal Reserve (Fed) on Jan. 22 slashed a key interest rate by 0.75% to 3.5% to quell those fears. A $150 bn Fed injection to stimulate the US economy seemed to be merely delaying the inevitable. Deeper recession could cut into energy use and slow demand around the world, and is likely to halt paper WTI's upward march, which briefly rose above $100/b on Jan. 3 on tight supplies, geo-political risks and a falling dollar. Big integrated IOCs like ExxonMobil, Shell, BP and Chevron would weather the recession better than those focusing on E&P with more direct exposure to commodity prices. E&P firms like Anadarko, Apache and Devon as well as most state-controlled national oil companies (NOCs) across the globe would be among the losers.

The diversified nature of the integrated companies, which have refining and petrochemical industries as well as E&P operations, plus international exposure, should help cushion the fall. Shares of oil firms have already taken a hit this year. Benchmark Co analyst Mark Gilman says the depth of WTI's drop depends on how closely energy markets track fundamentals, adding: "Fundamentally there is every reason to believe...they are cyclical. Demand is directly proportional to the level of economic activity". But Gilman and others say paper oil prices have not always followed the fundamentals, so it is difficult to guess the size of a potential fall-off.

The price of paper WTI contains more than one risk premium, not only because it is mostly a dollar bubble but also in view of capacity shortages across the whole chain of the world's business in physical petroleum. The political risk premium is usually higher than the risks pertaining to supply-demand fundamentals for physical petroleum. But all premia will collapse in the event of war; the IEA powers will release strategic oil stocks as in early 1991, when the US led a war to liberate Kuwait from Saddam's Sunni/Ba'thist dictatorship.

No one knows what the bottom line will be for the price of paper WTI. Many say it will be above $60/b. But many others say it could be below $50/b. It will certainly be well below the level it reached in late 1979 - in terms of today's US dollars and the difference in inflation since then.

As the White House on Jan. 25 confirmed the $150 bn economic stimulus plan, paper WTI rose $1.84 to $91.25/b by 1519 GMT. It had jumped nearly 3% on Jan. 24 to settle at $89.41/b. Paper Brent was $2.06 cents higher at $91.13/b. The stimulus package of tax cuts for families on Jan. 24 pushed up global stock indices, giving oil a boost despite mildly bearish US inventory data which showed crude supplies up 2.3m barrels in the previous week, slightly above analyst expectations. US gasoline stocks swelled 5m barrels, well above forecasts. In Davos, IEA Executive Director Nobuo Tanaka on Jan. 25 said OPEC should produce more to replenish stocks and ease high prices, while NOCs must keep up the pace of investment in new capacity. He said oil stockpiles were still "very tight", adding: "The price level is quite high...".

Gold on Jan. 25 closed at $912.20/ounce. It hit a record of $914/ounce on Jan 15, up from a low of $253/ounce reached during September 1999. That was almost a four-fold increase in a little more than eight years, a key sign of rising global inflation.

Funds and speculators had been exiting open positions in oil and other commodities to cover margin calls and finance losses in equity markets. Oil had plunged on Jan. 21-22, as world stock markets posted their steepest losses since 9/11 amid widespread concerns that the impact from the US credit and housing crisis triggered a recession, curbing a steady rise in oil demand which had fuelled prices for five years.

During World War II USA was half the world's economy. Now the US economy is $14 trillion, about 28% of global GDP of $50 trillion. But today the US consumer accounts for 19.5% of global GDP. So, while the American share of world GDP has gone over the last 65 years, the globe is still one-fifth dependent on the US consumer.

The US housing market is worth about $22 trillion. The OECD residential market is about $70 trillion, from $40 trillion in 2001, excluding the EEs where data are very difficult to gauge). Today the gross national debt of the US stands at $9.2 trillion. On 9/11, it stood at $5.8 trillion.

The Bank of England, which used to rule the globe before World War II, now is unable to handle the sale of the troubled mortgage lender Northern Rock, one of the UK's ten largest banks. Northern Rock got caught holding US subprime mortgages which have been significantly devalued. The British Treasury says that, together with Goldman Sachs, it would facilitate a sale of Northern Rock by converting a pool of the company's assets into bonds for sale to investors. Northern Rock would sell government-backed bonds to help repay about [pounds sterling]25 bn ($49 bn) it borrowed from the Bank of England last September.

If US inflation picks up, the Fed will be stuck and may even raise rates. The Fed is betting the recent economic slowdown is "deflationary" and so allows it to lower rates without much harm. But economists say by printing more dollars the Fed will only fuel further inflation in EEs which are pegged to the dollar and hence will enjoy the same low US rates. This will further turbo-charge red-hot EEs. In turn this will lead to inflation in EEs, which will move back to Europe and the US. The European Central Bank is nervous about lowering rates; it fears inflation, whereas the Fed in the US is choosing to ignore it for now. Canada is a commodity-economy, so it will sustain high GDP growth in the near-term, until the commodity super-cycle ends.

On Jan. 22, OPEC saw 2008 world demand growth at 1.3m b/d to average 87.07m b/d, unchanged from its December estimate. It said: "The effect of high oil prices on consumers might have a moderate impact in the short run, especially in the OECD. The same effect is diluted elsewhere, especially in regions that represent a large share of world oil demand this year because of price subsidies that shield consumers, such as in China, India and OPEC member countries". It said North American winter needs for oil will grow 0.33m b/d to average 26m b/d, year on year, which will underpin demand. It expected strong winter needs in the OECD to contribute to world oil demand growth reaching 1.5m b/d in the first quarter of 2008, year on year.

OPEC said: "Combined with uncertainty impacting demand growth due to rising fears of a recession in the US and economic slowdown in other regions, this has resulted in an even higher level of uncertainty for the estimated demand for OPEC crude... A spate of negative economic data for December has increased fears that the US economy will slide into recession in 2008. The overall forecast for the US economic growth in 2008 has been revised down by 0.2 percentage points to 1.8%, with an expectation of little to no growth in the first quarter".

OPEC's demand outlook was markedly lower than the IEA's Jan. 16 forecast for growth at 1.98m b/d in 2008. Despite consumer pressure to raise output at its Dec 5 meeting in Abu Dhabi, OPEC kept production levels unchanged at 27.25m b/d. OPEC expected US supply in 2008 to reach around 7.65m b/d, a growth of 159,000 b/d compared with 2007 and a downward revision of 44,000 b/d from its December assessment. It expected non-OPEC supply to average around 50.63m b/d, up 1.08m b/d over the 2007 figure and a downward revision of 117,000 b/d from its December report.