Message-ID: <2411975.1075840260748.JavaMail.evans@thyme> Date: Thu, 21 Sep 2000 10:36:00 -0700 (PDT) From: helen.tunley@gs.com To: pghemawat@hbs.edu, cwimmer@weeklystandard.com, llindsey@aei.org, portney@rff.org, stelzer@aol.com, rzoellick@gmfus.org, klay@enron.com, jeff.skilling@enron.com, bgrady@carlylesf.com, ghamel@strategos.com Subject: Message from Gavyn Davies re: The Global Oil Price Shock Mime-Version: 1.0 Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: 7bit X-From: "Tunley, Helen" X-To: "'pghemawat@hbs.edu'" , "'cwimmer@weeklystandard.com'" , "'llindsey@aei.org'" , "'portney@rff.org'" , "'stelzer@aol.com'" , "'rzoellick@gmfus.org'" , "'klay@enron.com'" , "'jeff.skilling@enron.com'" , "'bgrady@carlylesf.com'" , "'ghamel@strategos.com'" X-cc: X-bcc: X-Folder: \Kenneth_Lay_Dec2000\Notes Folders\Notes inbox X-Origin: LAY-K X-FileName: klay.nsf To: Ken Lay, Jeffrey Skilling and the Enron Advisory Council From : Gavyn Davies, Goldman Sachs Re - The Global Oil Price Shock Since our meeting in Houston, the spike in world oil prices has gripped the attention of financial markets. I attach a paper which analyses the genesis of the present oil price increase, the likelihood of it proving permanent, and the probable impact on the world economy. The bottom line is the following: 1. The recent increase in the oil price has been due fundamentally to an increase in global demand, and not to the activities of OPEC, operating as an oil cartel. In fact, OPEC does not seem to have enough immediate supply headroom to make much difference to the situation for many months. The danger of shortages will therefore be very acute this winter, even with normal weather conditions. This could lead to temporary spikes in the price to well over $40/barrel. We see a similar situation, or worse, developing in natural gas. 2. However, we do not see this situation as permanent. In terms of deep fundamentals, the equilibrium price for oil in the long term is still only about $18/barrel. Within about 12 months, a large increase in the supply of oil should push prices back down again, possibly quite sharply. Our present forecast for the average oil price in 2001 is $27/barrel, somewhat below today's spot price levels. But we do not expect to see this oil price downturn before next summer. 3. If oil prices do indeed average $27/bl in 2001, this will prove to be an oil shock for the developed economies which is the same in magnitude as the Gulf War shock a decade ago. It will reduce net disposable income for the OECD economies by about 0.7%, and add about 0.9% to headline inflation numbers. All of these effects will already be in the data by about 2000 Q4, so on our main forecast there should be little or no further adverse effects through 2001. 4. On this oil price scenario, GDP growth in the developed economies will slow from about 3.9% in 2000 to about 3.4% in 2001 - not a bad out-turn. 5. What if the oil price sustains $40/bl next year? This would give us another round of effects about the same as those mentioned in para (3) above. Even then, however, these effects should not be enough to push the world into recession. Growth should still be adequate at about 2.5-3.0%. 6. The main risks to this conclusion are that a spike in oil prices, and possible oil shortages, this winter cause a drop in equity prices, and a large dip in business and consumer confidence. This could then lead to a more pronounced downturn in GDP next year, especially if it triggers the kind of correction in the US that Larry and I have been worrying about for a long time. But this should prove just about avoidable, assuming sensible policy responses.. 7. This may therefore all work out a bit like the winter of 1998/99. Going into the winter, events occur which make people worry about recession. Business and consumer confidence, and equity markets, take a dip. But then things improve, and it all turns out to be a buying opportunity. 8. I hope so, anyway! Best wishes, Gavyn ,2000 Goldman, Sachs & Co. All rights reserved. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. We are not soliciting any action based upon this material. This material is for the general information of clients of Goldman Sachs. It does not take into account the particular investment objectives, financial situation or needs of individual clients. Before acting on any advice or recommendation in this material, a client should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. Certain transactions, including those involving futures, options, and high yield securities, give rise to substantial risk and are not suitable for all investors. 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