Oil, gas prices may dip further

Investors' retreat bodes more relief

January 23, 2007|By McClatchy-Tribune

WASHINGTON -- After a year of oil prices so high that analysts warned they might hit $100 a barrel soon, prices are falling, financial speculators are running for the exits and analysts are pondering whether oil could fall below $30 a barrel by spring.

Oil cost $41 a barrel on average in July 2004, when its price began its climb. It's not farfetched to think that it might fall to that soon. Back then, gasoline sold nationally for about $1.90 a gallon.

There's no guarantee that it'll happen again, but several factors point to at least a few months of lower oil and gasoline prices:

Oil production globally is no longer drum-tight. A warm winter eased demand and a mild hurricane season allowed damaged production to come back on line. That weakens sellers.

Oil producers are in some disarray, now that it's a buyer's market. A few vocal OPEC members want to cut production to shore up slumping prices, but OPEC's most important producer, Saudi Arabia, has rejected that for now. Saudi Arabia now boasts 3 million barrels per day of spare production capacity, after two years when global oil supplies barely could match demand.

Some analysts suggest privately that Saudi opposition to OPEC cuts is based more on politics than business. The Saudis, they say, want to starve rival Iran of needed oil revenues because Saudi rulers are Sunni Muslims and increasingly worried about Iran's backing of fellow Shiite Muslims who rule Iraq.

Lower prices could spell relief at the pump for American consumers, at least for the short term. Oil dipped briefly below $50 a barrel last week and, after volatile trading yesterday, closed at $51.13. Gasoline prices trail falling oil prices by a few weeks, but the AAA Motor Club reported yesterday that the nationwide average for a gallon of unleaded gasoline stood at $2.16. That's down 18 cents from just a month ago.

Falling oil prices make it cheaper to drive, heat a home, run an airline or deliver packages overnight. Lower oil prices, if sustained, should make airline tickets cheaper and lower the costs of shipping packages.

Predicting prices depends not only on production and consumption trends but also on money managers who have pumped billions of dollars into contracts for future oil delivery.

These institutional investors include hedge funds - investment pools for the very wealthy - as well as companies that manage pension funds and 401(k) retirement plans.

Two decades ago, oil was largely sold by producers to direct users such as airlines, trucking companies and manufacturers, who took delivery of the oil.

Today, more than 500 financial "energy funds" buy and sell contracts for future delivery of oil, or futures. These investors have put anywhere from $70 billion to $150 billion into oil trading in recent years, according to estimates. They don't want the oil; they just want to profit from trading in it.

"Once oil leaves the ground, whether it is in Saudi Arabia or in Texas, it is in the hands of speculators," said Fadel Gheit, an energy analyst in New York for Oppenheimer & Co., a financial services firm.

When global production was barely sufficient to meet demand, oil prices rose on the slightest hiccup in politically unstable oil-producing nations such as Nigeria or even tiny Ecuador. Oil peaked at $78.10 a barrel in July.

Today, the question is how far prices might fall, and institutional investors may hold the answer. With oil prices falling, their investments face growing risk.

"If pension funds decide they don't want to take the risk anymore and bail out, we could see prices go a ... lot lower," said Philip Verleger, an oil economist who's gained a reputation for early warnings on oil-price swings. "I think prices could dip below $30 [a barrel]. It really depends on what these pension funds do."

"You have the possibility for a significant break in prices," agreed Bill O'Grady, assistant director of market analysis for A.G. Edwards & Sons, a financial services company.

Still, O'Grady cautioned, consumers shouldn't expect energy prices to stay low for long.

"What a consumer is really looking at is a world where oil prices are going to be a lot more volatile," he said. "It is a world where there's just a lot more risk on both sides. When consumers hear risk they think of prices going up. When producers hear risk, they hear prices going down. And they're both right."

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