Lower oil prices are now on the horizon

The principle export of the Gulf States is of course oil followed by gas, and recent production cuts have already set 2007 on a course to be a lower year for hydrocarbon revenues than in 2006. Local stock markets have crashed and largely discounted this factor.

But most economists are working on forecasts for 2007 that assume a historically high oil price, in the $50-60 range. Yet to follow historical trends more closely we have to expect a bull market in oil to correct to its historic mean price, and that is only $24-a-barrel and markets do usually overcorrect on the downside.

Is this then likely to be a repetition of 1999 and the dive to oil below $10-a-barrel? That might be unduly pessimistic but the oil price optimists are the ones looking more and more unrealistic in their prognosis.

US recession threat

For as in 1998-99 with the Asian Financial Crisis there is a storm breaking in international financial markets, and it does not appear to be over yet. What will really finish this process is if the US goes into a recession on the back of the housing loan crisis now enveloping the nation.

For if stocks then pull back industrial commodity prices will also take a hit. This is only logical as a recession means significantly lower demand for oil, therefore the price goes down.

The oil price fall could be magnified by two critical factors. First, the hedge funds have added around $30 per barrel to the price through speculation which would be quickly unwound in a recession and market sell-off scenario.

And secondly the dovish moves in the Middle East by the principal players in the ongoing geopolitical crises threatens to undermine the war-premium attached to oil and gas, for if peace breaks out then the higher risk premium is no longer justified.

Peace threat

Now this second proviso does assume a lot. It is only a few weeks since the Israelis were apparently threatening to bomb Iran's nuclear facilities. But as the position in North Korea demonstrates it is possible to achieve a face saving compromise on nuclear issues if the will is there from all the parties.

Iran's economy would be bankrupted by a substantial fall in the oil price, and that is one reason to believe their authorities will be slow to reach such a deal. But with diplomatic activity now at fever pitch it could be that cooler heads prevail.

For the Middle East peace would come at a high price. The oil price boom that has been sustained by the global expansion led by the US economy is already under threat from a US recession, and a real reduction in geopolitical tension could send prices down to levels not seen since the Asian Financial Crisis.