Baker Institute Rice Faculty Scholar | Chair in Islamic Economics, Finance and Management
Executive Director for Energy and Sustainability, University of California, Davis
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The global "great recession" was precipitated in part by record high prices of oil and other commodities. Previous severe recessions have typically resulted in significantly lower energy prices, which in turn spurred growth and fueled a healthy recovery. The result is a short-to-medium term forecast of weak to modest growth, which — combined with continuously falling energy intensity of GDP — means that oil demand will remain stagnant or at best grow modestly. Under these circumstances, surging supply from U.S. shale and similar technologically-driven unconventional oil sources is likely to create excess supply and put strong downward pressure on oil prices. Voluntary reduction in oil production to prevent falling prices is highly unlikely, because swing producer Saudi Arabia and other GCC countries need revenues at the level of current volumes and prices in order to meet core budgetary requirements and prevent regime-change risk in the aftermath of "Arab Spring" revolts. Our wavelet analysis of all countries that have ever produced more than one million barrels of oil per day shows that regime change by itself would not result in significant reduction in oil production — although it may result in lower investment and therefore prevention of further increase in production capacity. However, war that destroys physical installations for the production and/or transport of oil can significantly disrupt oil supplies. In sum, if the outright war scenario is excluded, we expect prices to fall precipitously in the medium term (3–5 years). However, the continued threat of currently-contained civil wars into larger confrontations can maintain the current prices, especially if unprecedented monetary easing continues.
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