Now that international crude oil prices have retreated to around $106 (about Rs4,706) a barrel from a high of $147, the question everybody is asking is how much further can they ease. If we assume we’re going to have a global recession similar to the one we had after the bursting of the technology bubble, then it’s worth our while checking what happened to oil prices at that time.
A global recession is technically defined as growth below 2.5%. By that criterion, the last recession the world had was in 2001, when gross domestic product (GDP) growth fell to 2.22%, from 4.67% in 2000. Nymex crude oil prices, which had gone above $35 a barrel in September and October 2000, fell briefly below $20 a barrel in late 2001 before recovering in April 2002 to above $26 a barrel. According to the graphic shown below (which shows the month-end prices) oil prices fell from $33.12 a barrel at the end of August 2000 to $19.44 a barrel by the end of October 2001. To cut a long story short, the fall in oil prices from the peak to the lowest point was about 44%. This time, at around $106 a barrel, oil prices are already about 28% off their highs.
Long Way To Fall (Graphic)
The world recession before the 2001 one occurred during 1991-93—global GDP growth was 1.45% in 1991, 2.02% in 1992 and 2% in 1993. At that time, taking the month-end price figures, crude oil prices went down from $39.5 per barrel at the end of September 1990 to $14.17 per barrel by the end of December 1993, a fall of 64%. Admittedly, the peak oil price at that time was the result of the first gulf war, so the situation then was very different from the present. At the same time, the recession of the early 1990s had some features common to the current downturn—they both had a housing crunch in the US at its core.
If the current slowdown mimics the recession of 2001 and oil prices drop by around 44% or so, then the lower level for crude could well be within the $80-$90 a barrel level. If, however, this recession is going to be longer and deeper, closer to that of the early 1990s, then the drop in oil prices would be much more.
Which is the more likely scenario? Those who argue that oil prices are not likely to fall much say that the world of 2008 is very different, with emerging market growth well above the levels they were at in 2001 on the one hand and with supply constraints on the other. For example, in its August short-term energy outlook, the US government’s Energy Information Administration said it expects crude prices to average $124 a barrel in 2009.
Also, there are those who argue that oil has been a massive bubble and we’re going to see a major correction in oil prices. A research note from broking firm First Global, for instance, says, “Over the next 12-18 months, we expect oil prices to reach around $50 a barrel, which is roughly the same level from where the current oil bubble began. And who knows, we could see oil back at $30 over the next couple of years.”
In 2001, only one large sector—technology—was hurt badly. This time the cause of the downturn is the US housing sector and research has shown that it takes much longer for an economy to climb out of a housing bust. Add to that the impact of the bust on big banks and the currently ongoing process of de-leveraging, the current slowdown is likely to be worse than in 2001. That calls for lower global growth and bigger declines in commodity and oil prices.
India’s premium rises against other emerging markets
The Indian market has been one of the chief beneficiaries of the fall in international crude oil prices. According to the S&P/Citigroup Global Equity Indices, the one-year forward price-earnings (P-E) multiple for Indian market estimates (based on earnings forecasts from IBES, or the Institutional Brokers’ Estimate System) was 14.98 at the end of August, a 38.5% premium to the P-E multiple for emerging markets and a 20.6% premium to Asia-Pacific emerging markets.
At the end of July, the Indian market traded at a forward P-E multiple of 14.4, a 26% premium to emerging markets and a 15.4% premium to Asia-Pacific emerging markets. At the end of June, India’s premium over emerging markets was even lower, at 12.4%, while that over Asia-Pacific emerging markets was 11.4%.
The premium over other emerging markets has come down quite a bit from 64.2% at the beginning of the year, but it has increased once again in recent months as oil prices waned.
That’s not very surprising. But what is unexpected is that the Indian market is now cheaper than the US, where the one-year forward P-E multiple at the end of August was 15.23. The US market was at a 19% premium to the global market P-E at end-August. At the beginning of the year, that premium was just 7.6%. Despite being at the centre of the storm that has battered global markets, the US has done very well indeed.
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