Oil’s Temporary Respite

As oil prices drop the sense of relief is palpable for most consumers as they see sub $3 gas at he pump. Media headlines have also done an abrupt about turn, with headlines changing from “When will crude hit $200…” to “How fast can oil prices come down..”. The 20% fall this month has many people coming out and saying that the worst is behind us and that we are out the high gas/oil spiral. Some are even taking the rapid drop as a sign that high prices were caused by speculators and a much undervalued US dollar (which has also rallied more than 10% recently).

Oil’s certainly not cheap by historical standards, but the $145 and change record of early July begins to resemble an anomaly as it recedes in the rear-view mirror. After all, it has been a quick, jarring ride. Just a year ago, oil futures were changing hands at $72. So even at the current prices, we are still up 70%. Gas prices have risen a more modest, yet as painful, 30% over that time.

The current fall in prices is due to various short term factors. Consumers are drained amid credit and housing woes, and crushing gasoline prices have compelled them to conserve. India, one of the Asian tiger economies and a big consumer of oil, seems to be slowing much faster than expected. A rapidly strengthening dollar is dulling commodities’ allure for traders and speculators. The Olympics are creating a sense of world harmony, a weaker than expected tropical storm season and a relatively quiet Iranian agitator-in-chief have calmed portfolio managers and oil traders attuned to weather and geopolitics.

However, we are not out of the woods by any stretch and my view is that high gas prices will return. Why you may ask?

Factors that will contribute to the higher long term energy prices:

– The planet remains in a state of energy stress. Asian countries are adding an estimated 50,000 new cars per day to their roads. Adding this growth plus that from other oil based consumables, will provide a huge demand side effect. With supply limited and growing very slowly, this will lead to a steep rise in prices.

– If China’s oil demand growth rate continues at its current pace of 6% to 7% per year, China will use up to 40 million barrels per day – twice what America uses now.

– Tensions between Iran and the U.S. and other Middle east countries don’t look like abating in the longer term despite recent diplomatic efforts and a lull in tensions.

– We’ll drive more, fly more and waste more. As prices fall, the alliance of environmentalists and consumers, brought together by pain at the pump, is already coming apart. When has is below $4, people will think of it as a relief and unfortunately most will go back to their old habits. Holidays that were put off in the summer due to high gas prices, will now be back on the Agenda.

– Renewable energy is still a long way from being a viable alternative to oil in terms of widespread usage. The world economy cannot and will not quickly convert from an oil-based consumer to a blend of other energy options such as natural gas, solar, wind and so on,” said Neal Ryan, a manager at Ryan Oil & Gas Partners. “Until we do, I certainly expect oil prices to remain at these elevated levels over $100 a barrel and eventually challenge their all-time highs again — and then surpass them in the coming year.”

– The recent pull back is an expected market correction. The price can go back up as fast as it fell, particularly if the US dollar (in which the global oil trade is conducted) weakens again on bad credit or economic news. Speculators will come back during any periods of uncertainty or weakness and once again become a factor in high oil prices.

I don’t think oil prices will go anywhere near $200 by year end or that gas prices will get to $5. My view is that oil and gas prices will finish the year around $130 and about $4 respectively. However, unlike the 70’s energy crisis that went away after a few years, I think the current factors behind high oil prices is more permanent which means we will see $200 oil by the end of this decade. The best way to deal with this is for people to continue gas conservation techniques and habits when $5 gas was expected, rather than forget the lessons learned. The government especially should learn from the recent experience and focus on developing a long term sustainable energy policy that will reduce America’s dependence on oil, and hopefully one day eliminate it. That is the only way we will be rid of high energy prices and its adverse impacts.

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