A Double Dip

Rising oil prices could drive the global economy into another recession.


In 2010, oil demand will resume its upward march. OPEC will respond by increasing supply — but the lag will come too late to keep prices down as emerging-market consumption pushes them up. In the extreme case, resurgent oil prices could drive the U.S. economy into a double-dip downturn. Here’s what to expect, and what a limited oil supply will mean for the United States and the world.

As the global economy recovers, oil demand will continue to strengthen from the 85 million barrels per day that it hit in November. That’s already 4 percent higher than it was at the recession’s trough in May of last year. As a result, inventories both onshore and offshore have begun to decline. The number of tankers storing crude oil in the Gulf of Mexico, for example, fell to seven in October from a high of 22 in May.

Many rightly see this trend as a sign that recovery from the deepest recession in generations is happening. But this nascent resurgence holds the seeds of its own destruction. As oil prices rally, economic performance and employment could remain subpar, and a new recession might even be in the offing. The investment bank Goldman Sachs has forecast oil to hit $90 per barrel in 2010. That would mean the United States would be spending 4.5 percent of its GDP on oil, putting the kind of burden on its economy that has historically triggered recessions. According to an analysis prepared by my consulting firm, the U.S. economy has slipped into recession whenever crude oil consumption has exceeded 4 percent of GDP.

Not all countries will share the pain. Oil producers will do quite well. OPEC has described $75 to $80 per barrel as a "fair" price, and "fair" in this usage means "quite good." Of course, OPEC has no interest in a U.S. recession, either. It will try to keep oil prices manageable and in 2010 will have the spare capacity to do so. But OPEC tends to react with a lag, partly due to delays in data availability and in part due to sheer logistical complications. Meanwhile, oil prices will keep slowly rising.

As they do, watch out. Once higher prices help pull the Russian economy out of the doldrums, confidence will return to a Kremlin that has demonstrated a taste for power projection and Georgian real estate. Critically, Georgia is home to the BTC pipeline, an oil-supply link between the South Caucasus and the West. With such a prize in its grasp, Russia might be tempted to finish the job it started in 2008. Then there’s China, a growing oil consumer whose fate is tied to the U.S. economy. A struggling U.S. will thwart China’s export-led strategy, causing Chinese leaders to focus on their domestic priorities.

The more distant future could be even worse. Macquarie, a leading natural resources investment bank, sees worldwide oil-production capacity as having peaked in 2009. (Others, including my firm, forecast the peak coming around 2015.) So Obama may well find himself the United States’ first peak-oil president, with all the challenges that entails. Not only will the world order be realigning before him, but the constrained global oil supply will mean that finding alternatives to America’s gas-guzzling ways is a matter of national survival.

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