Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
May 12, 2008
Crude oil production in the Middle East and Central Asia is forecast by the IMF to rise modestly in 2008 to 29.4 million barrels a day, compared with an average 28.4 million estimated for 2007.
Filling up a car in Cairo. High oil prices should fall somewhat, but probably only slowly. (photo: Khaled Desouki/AFP)
Regional Economic Outlook
Mostly reflecting higher oil prices, the region's oil and gas export receipts are likely to rise to $940 billion in 2008, close to $200 billion more than envisaged late last year, according to the IMF's Regional Economic Outlook.
The report on the Middle East and Central Asia, released on May 12, analyzed whether or not oil prices were expected to remain at high levels (currently above $100 dollar a barrel).
Learning from the past
It noted that since 1970 there have been five global recessions (with world economic growth falling to around 2½ percent per annum or less). The first two (1974-75 and 1980-82) were associated with large prior hikes in oil prices (reflecting supply shocks). But real oil prices did not immediately fall when the recessions began. They remained quite firm one year into each of the recessions, and did not fall significantly until world economic growth had clearly recovered.
By contrast, the following three recessions (1991-93, 1998, and 2001) were associated with declines in real oil prices at the outset (although these declines were not particularly large).
The report looked at the reasons for the difference. "It is possible that OPEC [the Organization of Petroleum Exporting Countries] had greater market control in the 1970s than it did during the 1990s. As a result, it was easier to prevent falls in oil prices (as demand weakened) in the 1970s than it was in the 1990s," the report said.
This observed pattern suggests that it would take a global recession to bring about a major decline in oil prices. Currently, the IMF is projecting a decline in world growth to 3.7 percent, which means that oil prices should not be expected to fall sharply if they are being driven solely by economic growth ("fundamentals"). Even if the world does go into a recession, history suggests that the effect on oil prices could be lagged, depending on how much discipline OPEC is able to exert.
Speculative impact
The IMF analysis said it is hard to explain current oil prices in terms of fundamentals alone. "The recent surge in the oil price (from $80 to over $100 per barrel) seems to go well beyond what would be indicated by the growth of the world economy. Producers and many analysts say it is speculative activity that is pushing up oil prices now. Producers in particular argue that fundamentals would give an oil price of about $80 per barrel, with the rest being the result of speculative activity," the report stated.
But it said it is difficult to get a direct measure of speculative activity. Open positions in oil futures more than doubled in size over 2003-07. Net long non-commercial positions at the New York Mercantile Exchange (NYMEX) briefly reached new highs in mid-2007, after which they declined, the report noted. "Yet, prices have stayed high even as these speculative positions were unwound. Moreover, there is evidence that changes in net long non-commercial positions generally follow price changes rather than lead them. So this line of reasoning would imply that speculation is not the cause of recent increases in oil prices," the report concluded.
Another way to get a sense of speculative activity is to compare movements in the real price of oil with the real price of gold. This relationship has been surprisingly close for a long period of time. Gold is well known to be a highly speculative commodity, driven by factors other than derived demand. One could reasonably argue that this relationship, which has continued in 2008, is evidence of speculative behavior in oil. If the oil price does fall significantly in the near term, it may reflect more the unwinding of speculative positions in both gold and oil than indicate that a recession is under way.
In summary, it appears that speculation has played a significant role in the run-up in oil prices as the U.S. dollar has weakened and investors have looked for a hedge in oil futures. As financial market conditions settle down, fundamentals should take over and oil prices should come down further from the highs recently observed. How far they will come down will depend on how the world economy is doing, and if history is to be a guide, they will come down slowly.
Comments on this article should be sent to imfsurvey@imf.org
