The passing of peak oil?

Back in July, a barrel of crude cost $147. Fast forward three months and it is back under $70, amid fears of a global recession coupled with a significant slump in demand. So what does the drop mean for Gulf producers? Soren Billing reports.

When a goldman sachs analyst predicted that oil prices could reach $200 a barrel over the next six to 24 months in May, it sent shockwaves around the world.

Newsweek ran a cover that conceptualized what a future $200-a-barrel-world would look like, while the Los Angeles Times envisaged a breakthrough in telecommuting. All the while, Western governments railed against OPEC for refusing to increase output.

By September, the same analyst cut his 2009 oil price target from $140 to $110. Last week, Goldman Sachs slashed its 2009 oil price target by another $35 to $75.

"We clearly underestimated the depth and duration of the global financial crisis," a team of commodity analysts wrote in a research note. And yet $200 oil didn't seem like such a strange idea this summer, when a barrel of crude was nearing $147.

Three months later and it looks like most people are going to have to keep coming in to the office for work, at least for the next two years or so. This month, oil traded below $70 for the first time in 15 months, less than half its peak value.

Fear of a global recession is the main factor behind the drop, but it has been coupled with some real softening in demand, especially in emerging markets like China and India. Speculation in the futures market has also cooled down.

"Anecdotally speaking, when gasoline prices in the US hit the $4 a gallon mark you did see a sudden fall off in demand," Bobby Sarkar, a senior analyst at Al Mal Capital, tells Arabian Business.

"When oil went below $72-$73, it reached a technically important point which portends further weakness, at least in the near term."

Still, he now thinks the sell-off has been overdone. "You're probably going to see oil prices stabilise and go higher. Longer term, I think oil prices of $80 a barrel are sustainable."

Since OPEC's Sept 10 meeting, where it decided to lower supplies by 500,000 barrels a day, several analysts have cut their estimates.

Credit Suisse reduced its fourth quarter forecast two weeks ago to $75 from $110. It also pared its 2009 forecast to $75 from $110. Deutsche Bank reckons oil will average $92.50 next year, 23 percent lower than its previous forecast and down from $106 this year.

"The deteriorating outlook for world growth is leading to a violent correction in commodity prices," the company said in a research note to investors this month.

"We believe the nature of the slowdown in US and world GDP growth will have important implications for the degree and duration of commodity price weakness that may lie ahead."

BNP Paribas believes a further decline in the global GDP outlook could be a trigger for lower oil prices, with global growth of 2 percent or less likely to result in falling oil consumption.

"It's not a question of demand actually drying up," says Sarkar of Al Mal Capital. "The bull case for oil was that there is going to be huge demand for oil from India and China."That type of demand has not materialised and is unlikely to do so, he argues.

"Those economies subsidising fuel costs, it's just not sustainable in the long term. And you are seeing a lot of substitution into natural gas."

But while Russia, Iran and Venezuela have all based their budgets on oil prices that at the time of writing were close to the market level, it is unlikely that growth in the GCC will suffer.

DIFC chief economist Nasser Saidi says the UAE's economic growth will only slow if there is a significant downturn in its trade with the rest of the world. In a worst case scenario, the country's growth would only decrease by between 1 and 1.5 percent.

"The primary driver of growth is on the investment side [as opposed to consumption] and I think investments will continue at a high pace," he says.

In the 70s and 80s, Gulf states were highly reliant on oil revenues to finance their projects, but over the last five years the situation has changed.

"The accumulated surpluses have given countries a very strong cushion and enabled them to finance infrastructure and investment projects even though oil prices recede to below $80 or $90," Saidi says.

Governments across the GCC are basing their budgets on an oil price of $35 to $55 per barrel. Last week, a report from ratings agency Standard and Poor's said that if oil prices average $79 a barrel in 2009 from an expected $108 this year, Gulf public finances would "remain solid" and most regional countries would continue to post surpluses.

Saidi adds that many of the larger projects underway in the region, such as power plants and public transport systems, will be self-financing in the long term since they are based on user fees.

Merrill Lynch CEO John Thain was slightly less upbeat while talking to reporters in Dubai last week.

"Obviously economies that are petroleum-based have some degree of protection and economies that have strong degrees of domestic demand have some protection," he said.

"No country is decoupled from the global economy. The economies here will slow down, it's just a question of degree."

Despite efforts to diversify their economies, GCC countries still derive up to 90 percent of their export revenues from oil. Kuwait and Saudi Arabia are especially dependant on the oil sector.

About two thirds of the budget in all member states comes from oil.

"70 bucks is still a lot of money," says Dr Eckart Woertz, programme manager of economics at the Gulf Research Centre.

"Now we are comparing prices with $147 three months ago. We don't compare it with $30 five years ago."

Even if oil falls below $50 and some countries' budgets aren't balanced, they have been able so save a lot of money in recent years, and sovereign wealth funds (SWFs) could step in to fill the gap, he adds.

DIFC's Saidi believes SWFs could step up investment in their home markets, but not because they need to shore up their own economies.

Signs that Gulf Arab states are investing more at home comes against a backdrop of higher growth in developing economies, which is underpinned by massive infrastructure projects that are unlikely to be stopped.

"The US going into a recession does not necessarily mean that we are going to shave off half our economic growth," he says.