Good News??: A Recession Should Reduce Oil Prices

Exceeding last year's peak, oil prices today topped $80/barrel. This week's Economist explains what's changed:

The difference between now and then is OPEC's discovery that booming places like China have a seemingly unquenchable demand for oil. Oil producers, including those in OPEC, struggled to keep up. Prices rose, but demand kept on increasing too. By last summer, OPEC was already pumping as much oil as it could, and markets were fearful that hurricanes in the Gulf of Mexico or a political storm in the Persian Gulf would lead to shortages. The oil price duly rose to over $77 a barrel.

When those fears dissipated, it became clear that there was enough oil to go around after all. But by then, OPEC had developed a taste for $70 oil. So it cut production to stop prices from falling too far. When the oil price reached a new record of $78 a barrel last month, it was thanks as much to OPEC's diminished output as to runaway demand. The cartel has now proved that it has enough discipline to prop up prices by restraining supply if need be, and also enough spare capacity to temper prices when they rise too high for its liking. In other words, OPEC is back in control of the oil price. . .

That should worry OPEC's hawks more than it appears to. They seem to think that the world economy's ebullient growth over the past few years in the face of rapidly rising oil prices proves that it has developed immunity to oil shocks. The Chinese economy, for one, consumes more oil relative to its size than America's, but it is still galloping along. Americans, for that matter, show no inclination to buy less petrol even at prices over $3 a gallon.

Yet the laws of economics have not suddenly been repealed. Dearer oil will cut economic growth. Over the longer term, consumers respond to higher prices by driving more efficient cars and substituting other fuels for petrol. America's romance with gas-guzzling sports-utility vehicles appears to be fading and its affair with biofuels is ever more passionate. At the same time high prices are bound to constrain demand, and unpredictable economic growth and Middle Eastern politics make the future of both demand and supply uncertain. OPEC may appear to have regained control over the oil price, but it's not likely to last.