As the global downturn continues, the world economy faces a period of lower oil prices and overall demand for energy, a welcome change for consumers after the price spikes of recent years. But unless policy makers can find ways to improve the balance between energy supply and demand, the current slackness in energy markets will last no longer than it takes for the global economy to recover. That scenario will eventually impose significant costs on consumers and businesses in the form of higher energy prices. The importance of achieving a supply–demand balance extends, of course, beyond the next few years: in the longer term, demand seems set for robust growth.

As of late April 2009, the price of oil stood at around $50 a barrel—down from a high of nearly $150 a barrel in July 2008, though many observers doubt that oil demand will rebound enough after the current economic downturn to prompt another price shock. In terms of basic market forces, it’s well known that demand for oil reacts strongly to GDP levels. Sectors such as maritime shipping, trucking, petrochemicals, and air travel not only consume petroleum products heavily but also tend to overrespond to GDP downturns. On the supply side, the longer the downturn lasts and credit markets remain tight, the more high-cost supply projects will be delayed or shelved altogether.

What does this mean for oil markets? For starters, the tight demand–supply balance seen at the end of 2007 could return sooner than many observers might have anticipated. A spike in the price of oil could occur as soon as 2010 under the International Monetary Fund’s (IMF) “moderate” downturn scenario, which assumes a 4.7 percent GDP gap to trend with growth falling mostly in 2008 and 2009, followed by recovery in 2010. Under a “very severe” downturn scenario (which assumes a gap to trend of 10.8 percent), the time when spare capacity returns to the tighter levels of 2007 (2.5 million barrels a day) could be delayed until 2013, causing a potential price spike.

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