Oil could fall to $50 a barrel

Merrill Lynch slashes its forecast for 2009 crude prices of $200, saying in a new report that oil could trade as low as $50.

Grim scenario: Merrill Lynch's report said the appetite for oil has softened rapidly, which may result into weaker prices not seen in three years.

Merrill Lynch has slashed its lower-end forecast for 2009 crude prices, saying in a report that oil could trade as low as US$50 a barrel - a level not seen for three years. Such a collapse in prices would wreak havoc on many oil-exporting economies and derail efforts to develop alternative energy and tap crude from unconventional sources, analysts said. Merrill Lynch, which was taken over by Bank of America two weeks ago during a spate of bank bailouts, emphasised that the $50 forecast was "unlikely" and did not reflect the most probable outcome that oil would hold at about $90 throughout the year. "If the current global economic slowdown was to intensify into a synchronous global recession, which we still view as an unlikely event, we believe oil prices could fall further to $50 a barrel next year," the firm's commodity team wrote. In trading yesterday, prices for West Texas Intermediate crude fell $3 (Dh11) to $96 a barrel, despite the Senate's approval of a bailout plan on Wednesday, as traders feared an economic recession in the world's largest economy could slow global demand for crude. In its base-case scenario, Merrill predicted oil demand would grow by only 400,000 barrels per day (bpd) next year, a significant downwards revision from the firm's last report, which predicted demand would rise by 743,000 bpd. It predicted fundamentals could loosen further as three million bpd of new fields came online in the next year in Saudi Arabia, the UAE and Qatar. Merrill noted much of the evaporation in demand was concentrated in the US and industrialised countries - the so-called Organisation for Economic Co-operation and Development (OECD) countries. "OECD appetite for oil has softened up very rapidly, but US oil demand is imploding, far outpacing our initial expectations," the report said. "With the last two data points showing nearly a seven per cent drop in US oil demand, the ongoing contraction is reminiscent of the deep recession in the 1980s." Merrill's demand forecast is significantly more pessimistic than Opec and the International Energy Agency, which both recently predicted that world demand for oil would grow by 900,000 bpd next year. The former investment bank has historically been more conservative on crude prices than Goldman Sachs, which made news earlier this year by predicting oil would rise to $200. In June, in its most bullish forecast, Merrill predicted oil would average $121.50 per barrel through to the end of this year. Oil at $50 is "not out of the realm of possibility", said Dalton Garis, an associate professor of economics and market behaviour at the Petroleum Institute in Abu Dhabi. "I suppose oil could go south of $80: what it will depend upon is if China's demand continues to be robust," he said. "We don't really know how price-elastic their demand is for oil." Demand for oil had shrunk about as much as possible in the short term in the car-dependent US, Prof Garis said, meaning all eyes were now on changes to oil demand in China and other developing countries. A fall in exports to the US in the midst of an economic recession would undoubtedly shrink Chinese demand for crude, he said, but 42 per cent of China's gross domestic product was now generated my domestic consumption and analysts were split on how consumers' buying habits would respond to a worldwide downturn. Another key variable in any forecast of oil prices was Russia, which had built up its economy and military power on the basis of high prices and would likely act to keep prices high, Prof Garis said. The country has historically produced as much oil as possible and set an independent energy policy, but has recently hinted at closer ties with Opec and could join the group in cutting production amid a sustained price slump. If the oil price did crash, experts agree that it would deal a serious blow to new energy projects and economic development projects in exporting countries. Merrill Lynch estimated that some oil sands projects in Alberta would not be profitable if oil prices stayed below $100 a barrel. Interest in alternatives would also dry up. Wallace Tyner, a professor of agricultural economics at Purdue University in Indiana, estimates that US ethanol production is only cost-effective without subsidies if oil stays above $100. For the region, a crash in oil prices would have a significant effect on ambitious development plans. According to a report by PFC Energy, a consultancy based in Washington, Saudi Arabia needs prices to stay above $62 a barrel to balance its budget next year. The UAE and other Gulf countries have more conservative assumptions closer to $30 to $40 a barrel, but development projects and economic diversification efforts also would be likely to be put on hold. [e-mail]