Cheaper oil is already fuelling the next spike

LESS THAN six months ago analysts were predicting that the days of $200 oil were not far off. Over the first half of the year, increasing demand, driven by consumption in rapidly growing economies such as China and India, forced oil prices past $100 a-barrel and close to $150 in July.

This was against a background of collapsing equity markets that forced investors into safe havens such as commodities, putting further upward pressure on prices. The problem reached the point where the US Senate held an inquiry into what was happening to oil prices as the country's gas-hungry motorists began to feel the pinch.

Witnesses from the industry itself blamed "speculators" and "hedge funds" , the same people who became whipping boys for falling stock markets and the near collapse of the US banking system. They ignored the fact that demand and inventories played a far bigger role in determining prices.

Oil and natural gas are used to generate electricity in the Republic. Crude oil prices set the benchmark for both fuels. From a consumer's point of view, a sustained rise in crude prices means higher petrol, electricity and gas bills. Like their American counterparts, Irish motorists and consumers also paid the price. Petrol went to €1.20 a-litre and electricity and gas prices headed in the same direction.

The ESB increased its prices by 17.5 per cent in the autumn, bringing the average domestic bill to about €155. In July, the regulator gave Bord Gáis Éireann the go-ahead to increase its charges by 20 per cent, adding €13.75 a month to the average household gas bill of €907 a year.

Both were expecting to increase prices even further.

But by early December that had all changed. The Commission for Energy Regulation (CER) which determines what each State company can charge consumers and small businesses, did not allow them to impose further increases. Both companies had already conceded that they would not need any. The reason was simple - oil prices had tumbled by 60 per cent.

The day that the CER announced that there would be no further energy price hikes, it actually fell below $50.

It has firmed up since then as the Organisation of Petroleum Exporting Countries (Opec), a global cartel of oil producing nations, agreed a small cut in output at a meeting in mid-December, but it is still well shy of the highs it hit in July.

The good news is that over the short term experts seem to believe that oil will stay well below $100. Fatih Birel, chief economist with the International Energy Agency (IEA), told The Irish Times in November that prices would remain low into 2009 as the global recession suppressed demand.

Sustainable Energy Ireland recently agreed that this would be the case. However, the same observers also believe that, over the long term, the only way is up. Once world economies begin growing again, demand for oil will also increase, with the predictable impact on prices.

Even so, it now seems unlikely that they will reach the record levels touched in July. In a recent note, Citi analysts Mark Bloomfeld, David Thomas, Marc Kopfler and Fiona MacLean predicted that oil prices will overtake current levels, but not to the degree that they originally thought. They believe that oil prices will trade around $65 in 2009, well below the $90 that they originally predicted. They argue that the emerging economies that were driving much of the demand in the first half of 2008 are likely to fall into line with developed nations.

Over the medium term, which they are pegging at 2012, they believe that prices will reach $85, 15 per cent off the $100 that they originally forecast.

However, the Citi analysts stress that they remain "bullish" in the long term, and point out that the lower prices will contribute to the next spike. The reason is simple - poorer returns mean that there will be less investment in bringing new supplies on stream, which will ultimately mean that demand will once again reach a point where it is outstripping supply.

The IEA estimates that oil needs to trade at around $80 to encourage exploration and production. If the Citi analysts are right, then it is going to remain below this level for three years. That could give motorists and consumers some respite, but they could pay the price in the longer term.