Commodity Trading on the International Market-Oil at $200 a barrel by year’s end? |18 July 2008

After all, oil prices have doubled in the past year. More frightening, if you take the crude oil inflation rate of the past five years (which has seen prices quadruple) prices would rise to $580 by 2013, according to analysis by ING.

We already know the pain being felt over $145 oil – what happens if it jumps to even $200 a barrel by the year end?

According to ING, US inflation would hit 7 per cent. The impact on Europe would be more muted with inflation around 4.5 per cent. That rise in inflation would prompt the US Federal Reserve to raise its funds rate from the current level of 2.5 per cent to 3.5 per cent by the year end, and the European Central Bank would raise its rate from 4.25 per cent to 4.75 per cent.

ING says: “In turn this would compound the downward pressure on economic growth. The combination of a squeeze on consumers’ purchasing power from rising oil prices and higher interest rates would likely lead to a full blown recession in the US with the contraction of output deepening in early 2009. Output in the Eurozone would also be badly hit, although growth might narrowly escape slipping into negative territory.

“This environment would surely intensify the credit crunch. With activity slowing markedly, asset prices would tumble and default rates would climb. On top of this, rising short-term rates would add to the banks’ problems by squeezing their margins further. This is clearly a recipe for a vicious cycle in which financial sector woes and real economy weakness feed off one another.”

ING isn’t predicting that oil will hit $200 a barrel by the year end, and even if it did it says it wouldn’t be sustainable.

That’s because the damage to economic activity would be enough to drive oil demand down sharply and with it prices, plunging back to $100 a barrel by the end of 2009, leading to deflation and a sharp fall in interest rates.

Of course, mainstream forecasts don’t have oil at $200 a barrel by year end. But given how wrong economists have been about the rise in oil prices, neither can we dismiss the possibility. One thing we know for sure – if it happens, it’s going to be ugly.

Crude oil prices

As at 17/07/08

Nymex Crude Future  134.89 US dollars per barrel
Dated Brent Spot  134.54 US dollars per barrel