Will the oil price trigger the long-predicted double dip?

Back in March 2008, I put down my prediction that later that year the oil price would reach $145  – from the $110 it had reached then – and bring an end to world economic growth. Now we’re back at $90, will it happen again?

Some of the fundamentals of that analysis are certainly coming round again. particularly the long slow upward drift of the oil price as demand begins to approach supply. The IEA Oil Market Report predicts world oil demand rising to 88.8mb/d in 2011, up from 87.4mb/d in 2010, and peaking at 89.6mb/d in the third quarter of this year. In the same report, world oil supply is shown as reaching 87.4mb/d in the third quarter of last year.

No need here to repeat all of my early 2008 analysis, which you can read for yourselves, but on the face of it there is the potential for the mid-2008 scenario to repeat itself in at least some of its fundamentals: demand for oil could begin to exceed supply by a margin too large to be met by raiding stocks, and the price could rise rapidly until it is high enough to severely curtail world economic growth.

The next steps in the dance will necessarily be different: the sub-prime collapse won’t happen again this time, but on the other side there is essentially zero chance that we will see a repeat of the coordinated global fiscal action (aka government spending) to mitigate the depth of the slowdown.

Indeed, most of those governments that are pulling deep cuts to reduce their deficits are relying on continuing or even increasing general economic growth to mitigate the impact of the cuts and to provide increased tax revenues to contribute to the deficit reduction. If there is no growth, let alone another recession, the impact of the cuts will be magnified substantially and probably lead to some of those economies – not just the PIIGS, but also the UK and a number of other second-rank economies – having considerably worse deficits than they started with before the ‘deficit reduction’ exercises.

So, more likely a sovereign debt crisis than a banking crisis, but with cuts in spending all around, and no real chance of action to reduce the length and depth of the downturn. With demand potentially in free-fall and compounded by government spending cuts coming through to fruition, it would be unlikely that this time the Chinese economy can repeat the 2008-9 tricks, and thus the insulation of the Australian economy from the downturn won’t be repeated this time round.

‘Course, could be wrong, might not happen, maybe the supply curve can accelerate to meet Q3 demand. But maybe not.