Oil muscles past faltering U.S. economy

With oil over $100 despite a flagging U.S. economy, prices seem moved more by strength in global demand.

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By Steve Hargreaves, CNNMoney.com staff writer

Despite faltering U.S. economy, oil sets new record on back of strong global demand.
Crude concerns
Oil prices trading near record highs have added to the woes facing the US economy.

NEW YORK (CNNMoney.com) -- There was a time when oil prices needed the backing of a strong U.S. economy to reach record levels, but oil prices hit all-time highs again Wednesday even as a recession looms.

Clearly, a strong economy is still necessary to keep oil prices high, but it seems the United States is no longer oil's main driver.

"The really strong economy is on the other side of the world," said Peter Tertzakian, chief energy economist at ARC Financial, a Calgary-based private equity firm.

When crude closed at over $100 a barrel Tuesday, traders were quick to point to the short-term problems that led to the nearly $14 rally over the last two weeks: The spat between Exxon Mobil and Venezuela's Hugo Chavez, fears the Federal Reserve may cut interest rates again, sending the dollar lower, and talk of an OPEC production cut.

To some, the explanations sounded a little hollow. Antoine Halff, head of energy research at Fimat in New York, titled his research note on Tuesday's more than $4 price spike "A rally in search of a cause," attributing much of the gain to "capital's quest for safe havens and financial hedges against inflation."

But despite recession talk in the U.S. and, to a lesser extent, Europe, economies in the developing world are humming along quite nicely. That, along with some hefty subsidies in the Middle East and elsewhere, is the main reason oil prices have continued to break records, analysts say.

While the U.S. economy is expected to grow by an anemic 1.5 percent in 2008 and the prospects for Europe not much better, Tertzakian said developing economies in places like India and China are growing at an average rate of over 8 percent a year.

So while growth in oil consumption is nearly flat in the rich world, developing nations are eating up more and more fuel.

The world is expected to use 1.4 million barrels per day more in 2008 than it did in 2007, according to Lehman Brothers energy analyst James Crandell. Developing nations account for more than 1 million barrels of that growth.

Plus, while developing economies were once dependent on the rich world to sell their manufactured goods, there's a theory that even if a recession strikes the U.S., Europe and Japan, developing countries may be able to chug along on the strength on their own rising middle class.

"Are developing countries following the U.S. in lockstep," asked Crandell. "Our view is that even in a US recession, China and the Middle East will still show measurable oil demand growth."

Plus subsidies in many developing nations are keeping demand artificially high.

In most developed countries, gasoline prices rise and fall based on free market trading. This has led to higher gas prices as oil has risen - that price runup has also helped limit some of the demand.

But in many parts of the developing world, especially where unelected regimes are trying to make nice with the people, the government subsidies gasoline prices.

While Americans are paying over $3 a gallon at the pump and the Europeans, largely due to higher taxes, pay $7 a gallon or more, the Chinese shell out about $2.65, according to HernŠn Ladeuix, head of oil and gas research at the investment bank CLSA Asia-Pacific Markets in Singapore.

In Indonesia, the world's fourth most populous country - formerly a net exporter of crude until domestic demand ate up all its production - the motoring public pays about $1.82 a gallon, said Ladeuix.

But it's the oil-rich Middle East that really lays on the subsidies. In Iran, a gallon of gas costs 42 cents. In Saudi Arabia prices are actually falling - a gallon of gas is now 45 cents, half the price of two years ago.

"All this means not much incentive for consumers to reduce demand for oil," he said.

As a result, countries with heavy subsidies that represent just 18% of overall oil demand account for 80 to 90% of new growth in consumption, said Ladeuix. To top of page

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