Crude oil prices on slippery slope
'What if?' factors play into sinking price per barrel and consumer cost at pump
By Robert Manor | Tribune staff reporter
December 8, 2007
When oil hit a record $98.18 a barrel in late November, many thought the next threshold would be $100, followed by $110 and $120.
What a difference a couple of weeks can make.
The benchmark price of crude closed at $88.28 on Friday, down $1.95. Retail gasoline prices, while still no bargain, were also down Friday.
Industry analysts say a variety of factors is driving down the price of petroleum. Most of those factors begin with the words, "What if?"
What if Iraq continues to calm down and raises its oil output? What if the U.S. slips into recession, reducing the nation's demand for crude? What if growth slows in China and India, cutting their thirst for energy?
"I am bearish on oil [prices] for the first time in many years," said Phil Flynn, energy analyst for Alaron Trading Corp. of Chicago. "In 2008, I think prices will come down."
Flynn said the oil market began 2007 in a climate of fear. The surge of American military reinforcements into Baghdad had not begun and the country seemed to be spinning out of control, and with it the country's ability to pump as much as 2.3 million barrels of oil a day.
But geopolitical tensions have eased a bit in recent days.
Concern about conflict with Iran and its supposed nuclear weapons program has abated, taking oil prices back a bit. North Korea seems less antagonistic, which cools energy prices as well. Meanwhile, Iraq is producing at capacity.
Hints of peace are perhaps the most positive reason for the decline in oil prices. Other, less desirable factors are at work as well.
"It would not surprise me to see the economy slip into recession," said Paul Kasriel, chief U.S. economist for Northern Trust Co. At best, he says, the economy will be stagnant for months to come.
When the U.S. economy slows, it consumes less petroleum. That is already happening. Kasriel said that in September 2006, the U.S. imported 10.5 million barrels of oil. In September, that had dropped to 9.9 million barrels.
"Oil prices are more likely to move lower in the coming year than higher," Kasriel said.
Oil is the single largest component of the retail price of gasoline, although refining costs, taxes and other expenses contribute significantly.
In Chicago on Friday, a gallon of regular gasoline averaged $3.115, down from $3.125 a day earlier, according to AAA Chicago. Chicago typically is among the most expensive cities in the U.S. for gasoline, largely because of taxes.
For Illinois, the average price of regular gas was $3.054 Friday, down from $3.067 a day earlier. The price in Chicago is now more than 50 cents a gallon cheaper than in May.
Oil prices have been high for nearly all of the decade, and that encourages production, which is another factor in the per-barrel price over the longer term.
For example, extraction of a kind of crude from the enormous oil sand deposits of Alberta is not economical at $20 a barrel. It is highly profitable at $80 or $90, and energy companies are racing to increase output there.
The same principle applies to drilling for oil in deep ocean waters far from shore. Off-shore projects that once made no economic sense are now under construction.
Matthew Lewis, assistant professor of economics at Ohio State University, said it takes time to develop new sources of oil, but when they are on line they will affect energy prices.
"Over the next 10 years, the oil that is going to continue to come on line is eventually going to pull prices back down," Lewis said.
That does not mean oil could sink to $20 or $30 a barrel as it did in the 1990s. Lewis said $60 to $70 is probably a more likely range.
Numerous unpredictable developments could send oil or gasoline higher or lower in coming years.
A general economic slowing in the U.S. and Europe, besides cutting consumption there, would reduce demand in India and China, which depend on exports to the developed world for their rapid growth. Slowing economies in Asia would depress oil prices.
Weather can play a critical role, at least temporarily.
Hurricanes Katrina and Rita smashed U.S. refining capacity along the Gulf Coast, driving up the price of gasoline for months.
But a series of warm winters in the U.S. would tend to drive down gasoline and diesel prices, as refiners would not have as much competing demand for heating oil in the Northeast.
For energy traders, the cost of oil today is reduced to a question.
"The price basically represents a market debate over whether $88 is cheap or expensive," Tim Evans, an energy analyst at Citigroup Global Markets Inc. told Bloomberg News. "You're $10 off the high," he said. "Do you buy the dip or sell the rally?"
As I was expecting, the barrel stopped climbing somewhere close to $100 and then dropped down. For my guess to continue to hold true, it will drop to the $70s before climbing back up again. I figure that would be the last time we see it below $80.
worthy.
