Will the oil price go up before it goes down?

It was about four years ago that a respected local billionaire warned this correspondent that oil prices were about to turn down. Fortunately he is not in the oil business and has doubtless profited hugely from the boom of the past few years.

Yet how can you really be in business in the Middle East and not look at the oil price? And there is a new pattern emerging, which we can derive from analyzing two seemingly very different views.

Standard Chartered Bank's regional economist Steve Brice sees substantial downside risk to oil markets at the present time. Supply has been above demand for months, while the US economy is going into a slowdown which is not good for demand.

Geopolitical events

This is apparently at variance with a leading US oilman T. Boone Pickens who thinks oil will hit $70-a-barrel by the year-end. However, both commentators see a likely oil price spike on the horizon. Mr. Pickens notes that you can pretty much take your pick of possible geopolitical events that will spike oil prices above $100 in early 2007.

Mr. Brice also concurs and says that his forecast of falling prices carries a substantial risk of being caught out by a major geopolitical event. However, for both commentators an oil price spike would mark a market top or market blow-off.

Then follows the real downside: Mr. Brice is on the record as saying that oil will revert to at least its long-term average price of $24-a-barrel.

The real problem is that the evident US economic slowdown and possible recession in 2007 threatens to derail the Third Great Oil Boom. And while a geopolitical oil price spike might delay this effect, when you think about it this price impact would just make a US downturn worse and the impact on oil demand greater and therefore accentuate the oil price shift downwards.

US slowdown bad for oil price

So while reality might appear to be suspended for a brief period by an oil price spike, the follow through for the Oil States from a US slowdown is not likely to be a happy one. The best that might be hoped for is a short period of lower prices followed by a recovery due to demand from India and China.

However, if the US economy catches a cold then emerging economies might suffer pneumonia, and not just the emerging economies would suffer. Out of European countries the UK and Germany are those with the strongest US trade links; and Japan is a big exporter to the US.

In short it is hard to imagine that a US slowdown will be without a contagion impact and that will slow worldwide demand for oil even further and keep prices low.

This is actually not so controversial, as after a big boom in oil prices a prolonged slump is typical. To expect the reverse would be to argue that it is different this time, and that may not be true.