PrintJanuary 12, 2007
Oil prices on the way down
Phil Gallagher thinks gasoline prices are heading below two dollars a gallon. He points out quite correctly that the same speculators who helped drive up prices in the futures market are now scrambling to unload their positions, driving down the prices they once drove up.
He's right. These folks live and die by the adage, "The trend is your friend," and it works downward as well as upward. At the margins they may indeed magnify price swings on the market, but in the long run they don't affect overall price levels, which are and remain a function of supply and demand. For any volatility in the market caused by speculators, there is the compensating smoothing of prices for those who use the futures markets for that same purpose. Ask Southwest Airlines about it, if you do not understand, for that airline benefited greatly by buying futures and avoiding the swings of the market during the great run-up.
There's more good news:
A trend like this is going to be very hard for OPEC to reverse. You will hear on Bloomberg and CNBC about the cartel meeting to discuss emergency production cuts but getting a consensus on that is going to be very difficult. The one thing OPEC members have in common beyond the fact that they are oil producers is that they also cheat on production quotas.
The cheating will be necessary from a number of strategic perspectives for the producers. Iran is busy meddling in world affairs while simultaneously trying to build a nuke program and placate the masses at home. Saudi Arabia will need additional moneys to invest in the defense of the Sunni minority in Iraq as American involvement slowly winds down over the next year or two.
The cheating will be necessary from a number of strategic perspectives for the producers. Iran is busy meddling in world affairs while simultaneously trying to build a nuke program and placate the masses at home. Saudi Arabia will need additional moneys to invest in the defense of the Sunni minority in Iraq as American involvement slowly winds down over the next year or two.
Phil calls attention to the additional production coming in oil, thanks to the high prices, and also to the production of substitute fuels. But the expansion of supply is being counteracted by the secular rise in demand in China and India. Whether or not oil prices ever reach $30 a barrel is open to question. I suspect not, thanks to the large rise in consumption in the two large countries. Exploitation of Canada's vast tar sands requires $40 a barrel or so as a pricing floor, and this would be a geo-strategic benefit of great magnitude.
