Recession will not kill off US oil demand

A US recession will not kill off demand from the world’s largest oil consumer, despite mounting concerns that the global credit crunch could send the market into a lengthy slump driving down crude prices, Merrill Lynch said on Tuesday.

The investment bank said in a report that 70% of total US oil demand was now driven by fuels used for transportation and the effects of a relatively mild recession would be limited to “a very small impact on transportation fuels, such as gasoline, jet and diesel, supporting overall US consumption".

“The consumption of industrial fuels, such as distillate and residual fuel oil, has generally contracted quite sharply, by 3.2% and 6.5%, respectively, during the past six US recessions,” Merrill Lynch said.

“Gasoline demand contracted by only 0.5% and jet fuel consumption remained roughly flat in the same periods.”

However, the bank cautioned that the length and breadth of a recession would have a major impact on the severity of any drop in demand.

Merrill said oil demand declined an average of 2.3% over the past six recessions, the last of which was in 2001, sparking widespread fears that the current economic slowdown will hit oil exporters.

The US Federal Reserve has slashed interest rates to 3.5% over the last few months in an effort to stimulate the lagging economy, adding to concerns over a drop in demand.

“Demand growth usually slows down at the onset of major Fed easing cycles,” Merrill said.

It also said the drop in oil prices related to sluggish performance in equity markets due in part to the subprime mortgage crisis and ensuing credit crunch would only be temporary.

Oil prices crept towards $92 on Tuesday, down from its record high of $100.09 on January 4.

“Once macro uncertainty subsides, we expect this correlation to break down,” Merrill said.

The long-term outlook for oil prices remains bullish with the cost of exploration and production, nationalisation of foreign resources and "project disappointments" all supporting higher prices, it said.

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