Will the global credit crunch be a re-run of the Asian Financial Crisis and lower oil prices?

Opec members have just agreed to raise oil production by a modest 500,000 barrels per day in an eerie echo of 1998, when producers also raised output in the face of a financial crisis, albeit by a much larger amount. Increasing supply at a time of falling demand had a disastrous effect: oil prices fell below $10 a barrel in 1999.

Could it be that history is repeating itself? Geopolitics suggest not. The Middle East is considerably more unstable than in 1999, and other producers like Nigeria and Venezuela also look likely to prove unreliable. And certainly if oil prices slip there are plenty of trouble spots that producers might stir up to help prices recover.

However, the global credit crunch has already crossed the Atlantic and last week toppled fifth largest British mortgage lender Northern Rock. Now there is talk of contagion into the UK housing market from no lesser luminary than Alan Greenspan.

Back to the 70s?

If we look back to 1974-6, the last major banking crisis in the West, then what started in capital markets as a secondary banking crisis moved over into the real economy, depressing house prices and smashing the stock market. It took a serious bout of inflation and almost a decade to recover.

Oil prices, however, were very strong in the late 1970s and only dropped sharply after a final spike following the Iranian Revolution. Could it be that oil prices will escape again from the global mayhem?

It is true that global consumers will be reluctant to abandon their cars, and there are now 600 million of them to fill up. China's new car owners are not going to return to their bicycles. But we can expect the most severe economic downturns to be felt in emerging markets, and the Chinese stock market does look another accident waiting to happen.

Hedge funds

One other factor, often forgotten in analysing the oil markets, is the support that prices are getting from hedge funds gambling on a higher oil price. It has been suggested that up to half of the present price is a speculative premium, and that could be wiped out as a global financial crisis progresses.

So will it be like 1999 or the mid-1970s? Well if the US economy goes into a recession then it is hard to imagine oil prices staying high, but then again given geopolitical factors that is not impossible. In truth we do not know but in such an environment caution should be the watchword for business investment.

The long term average oil price is $24 a barrel and a correction to the long term mean price is usual in financial markets, but when this might happen is impossible to say.

See also:
China ripe for Middle East investment
No option for Fed except a bail out!
Sell! Global financial problems will get worse