Oil at $20? Not as absurd as it sounds

Funny how, no matter how complex the wizards of Wall Street and Bay Street try to make it, everything always comes back to Econ 101.

Why is the world's largest economy enduring an epic slump in home prices? Silly mortgages and funky debt products and blind-as-a-bat credit agencies played their part. But that went on for years, and prices kept going up. The crash began only when the number of new and empty homes got far out of line with the number of families who could fill them. Simply, it was supply and demand.

Why will oil drop to $20 (U.S.) a barrel? Same reason. It's just supply and demand. So says Philip Verleger, the energy economist and University of Calgary professor who is making headlines with his $20 prediction. As he told the Globe's Steve Ladurantaye, "this isn't complicated" - the taps are running but the buyers are disappearing because if you're unfortunate enough to be one of the 9.5 per cent of Americans or 8.6 per cent of Canadians or 8.3 per cent of Germans without a job, you don't need as much gasoline as you did before.

By winter, Mr. Verleger said, "we'll have this stuff coming out of our ears." Which is also where a few people in the oil patch would like the good professor to stuff his forecast. Twenty dollar oil? Ugh. Think about the implications for the Canadian economy. Every new oil sands project would go back on the shelf. Think of poor Jeffrey Rubin, too: His new book, which is all about what the world will look like with $200 oil, would get swept into the remainder bin in record time. One can almost picture tumbleweeds blowing through the subdivisions on the outskirts of Calgary.

In Alberta, it would be like the ugly, early 1980s again, minus the scapegoat of Trudeau.

Or would it?

Mr. Verleger's forecast, gloomy as it would be for Western Canada, can't be dismissed out of hand. About five years ago, writing in The International Economy magazine, he foresaw a quick rise to $60 oil, then $80, and - just maybe, if the script went just right - as high as $160. That's pretty much how it unfolded until last year's financial crisis. So the man has been right before. He résumé (Yale professor, former energy adviser to the U.S. government, etc.) tells you this is not someone who's making an outlandish prediction for the sake of getting some attention. There's real analysis behind this forecast.

But there are also a lot of ifs. It assumes that oil-producing countries won't be able (or willing) to cut their supplies, and that the global economy gets worse because Western governments are too quick to take away the fiscal stimulus and the low interest rates they've been using to fight the recession. "Absent strong immediate action, $20 by December 20 is not an absurd thought," he writes.

All of that could happen - but even then, we aren't likely to see $20 oil for long, if at all. And even at that, it isn't going to be a catastrophe for Alberta, because the province isn't truly an oil economy (not yet, at least). In most of the province, it's still a natural gas economy. That's true right up to the level of government finances, which remain more dependent on gas royalties than any other form of resource cash. A drop of $1 (U.S.) in the price of a barrel of oil costs the Alberta treasury $143-million in revenue. Natural gas need only decline by about 11 cents per gigajoule to do as much damage.

And for the first time since the autumn crisis, that crucial part of the West's energy economy appears to be stabilizing. Gas producers, sick of prices so low that they can't make a return, are pulling back. EnCana, the biggest of them, has just slashed its gas output by hundreds of millions of cubic feet a day. It's not alone. Prices have stopped falling.

Yes, there's still a ton of gas in the deep shale deposits like the one that Exxon Mobil has been exploring in the far reaches of northeastern British Columbia. But drilling for the stuff takes big money, and there are very few in the gas business who've got easy access to cheap capital. Besides, if the major governments of the developed world still want to cut greenhouse gases - and they say they do - where's the energy going to come from to fuel the economic recovery? Coal? Windmills? Dream on. "I, frankly, think [natural gas prices are]going to turn in a heartbeat - sooner than you think," says David Yager, who runs HSE Integrated, a Calgary oil services company.

Alberta will be fine even if $20 oil comes, which it probably won't.