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October 10, 2005

Falling oil prices

Over the weekend it occurred to me that I haven’t written about oil prices for almost three months. I also realized why: this has been the summer of oil-market Chicken Littles, and with almost everyone convinced the sky is falling, it seemed rude to remind them that—in the end—economics will probably sort things out.

In other words, this has not been a great year to be an oil bear.

Things are looking up, however. At a time when oil prices are usually starting to rise in anticipation of winter demand, they’ve actually been falling: at $61.50 a barrel, light crude is now about 13% off its Katrina peak, and still falling. And my guess is that prices still have a long way to fall, for a number of reasons.

First, growth in Chinese energy consumption—which most Chicken Littles use to explain why oil will soon cost $100+ a barrel—has stalled. In 2004 it increased by 17.5%; this year will see growth of well under 5%, and consumption is still slowing. This shift—in part a result of China’s fast-maturing economy—will have a huge impact on oil prices over the coming years.

Second, consumers in developed nations, battered by more than a year of sky-high gasoline prices, are starting to cut back. (The extent of those gas-price increases, by the way, should be the subject of government investigation across the developed world—the oil companies have been price-gouging their customers as never before.) U.S. oil demand was in freefall during September—and not just because some refineries were shut down due to Katrina and Rita.

As Econbrowser points out, Americans are dumping their SUVs at a rate that must terrify Detroit: last month, for example, Ford Explorer sales were 58% down on September 2004, Chevrolet Suburban sales were down 57%, and almost every other big American SUV saw 30%-60% declines. Sure, the fact that two major hurricanes blew away consumer confidence can explain part of this. But September is traditionally a banner month for auto sales, because it offers the best deals of the year. And buyers were snapping up smaller vehicles—sales of Honda Civics soared 37%.

There are other problems for the oil bulls too. Airlines are cutting flights and routes, consolidating, or simply going out of business—which means falling demand for aviation fuel. The continuing insanity of the Fed’s interest-rate policy—even though any signs of inflation are far outweighed by indications that the economy is starting to soften—may help tip the U.S. into recession next year. Retail sales are slowing rapidly (paid-subscription link) on both sides of the Atlantic, house prices are starting to stall, underlying employment numbers are looking shakier… and so on and on.

Oh, and then there’s the little matter of the oil-market speculators, who are starting to see the writing on the wall. Back in summer 2004, when oil was around $45, the industry consensus was that every barrel of crude carried a speculative premium of around $7-8. By this past summer, that premium had risen to at least $10, as hedge and pension funds made huge (and incredibly risky) bets on $100 oil. Now, with the more nervous speculators (read: pension funds) starting to unwind their positions, that premium is evaporating.

All of which leaves me back where I was in the early summer: predicting that oil prices will be close to $40 a barrel by late spring 2006.

Posted by Stephen at 12:58 PM in Energy + environment | Permalink | TrackBack (0)

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