How low can oil prices really go?

With the global economy teetering, the Organization of Petroleum Exporting Countries is coming under pressure to lower the price of oil before another worldwide recession does it for them.

Every recession since the 1970s has been preceded by a spike in oil prices, and it would appear as though we have just experienced another such jump. After dropping below $40 a barrel in early 2009, the price of West Texas Intermediate crude oil almost tripled in the ensuing two years, topping out at $115 a barrel earlier this year before dropping back to its current level of around $100.

Since help to stave off such a downturn is unlikely to emanate from fiscal policy — because the conversation has shifted from stimulating the economy to reducing budget deficits — there have been calls in some quarters for OPEC to ride to the rescue and lower the price of oil.

There is no doubt that a decline in oil prices would be quite beneficial to the U.S. and other oil-importing nations. According to the Economist magazine, a fall of $50 a barrel would be equal to a tax cut of $350 billion, in terms of the stimulus it would impart to the economy.

The questions then become: How likely is this to happen? Will OPEC recognize that lowering oil prices now will prevent an even bigger drop later on?

The answers are “not likely” and “maybe.”

On the first question, most people both in and outside the oil industry believe that supplies are much tighter today than they were in 2008, when the last plunge occurred.

While more Libyan crude is likely to come onto the market in response to the regime change in that country not long ago, it is likely to be offset by reduced supplies from Iran — whether because of its choosing or because of an embargo to pressure the country to halt its nuclear program.

On the demand side, the BRIC countries (Brazil, Russia, India and China) are growing rapidly, thus consuming prodigious quantities of the black stuff. And slowdown notwithstanding, the U.S. is importing more oil these days simply because it is exhausting its supply of oil from domestic sources.

As for the second question, you have to look at the needs of the oil producers, themselves.

Back in the 1970s, when oil was as low as $3.00 a barrel, the OPEC nations were able to get by very nicely. As oil prices rose, these countries ramped up their spending and thus counted on a certain minimum for oil to make their budgets balance. And this year’s Arab Spring caused many Mideast governments to offer stipends to their citizens in an effort to calm militant unrest within their borders.

According to calculations made by the International Monetary Fund, $80 a barrel is the break-even point in terms of OPEC’s budgets. That’s only about $20 below current levels for WTI.

In view of the widespread unrest, OPEC may very well decide to let the price of oil slide to $80, since anything lower could put their governments at risk. A small drop, but better than nothing.

MarketWatch