August 23, 2008
By JAD MOUAWAD
NY Times
Original article

VPO Note - Hmm, okay, so when the price goes up, it’s speculation, but when the price goes down, it’s supply and demand?

Until recently, it seemed that oil prices could move in only one direction: up. But in the last few weeks, the great energy rally that kicked off at the beginning of the decade has shown signs of running out of steam.

A combination of weak economic growth, slowing demand and shifting perceptions has sent oil prices down 21 percent from last month’s peak. Prices have fallen in two of every three trading sessions this month despite hurricanes looming over the Gulf of Mexico’s offshore wells, a war in the Caucasus that threatens Caspian supplies and more violence in Nigeria’s oil-rich Niger Delta.

Only a short while ago, such events would have sent prices still higher. But energy markets, which for years had focused mainly on risks to supplies, have suddenly started paying attention to the impact that high prices are having on consumers.

By any measure, oil prices remain high and have become increasingly volatile. Oil is up 19 percent this year and has been stuck above $100 a barrel since early March.

On Friday, prices dropped the most since 2004, falling 5 percent to $114.59 a barrel on the New York Mercantile Exchange. A day earlier, they shot up by almost 5 percent.

“The market psychology has shifted dramatically,” said James Crandell, an energy analyst at Lehman Brothers. “It now clings to the bearish news that was shrugged off early in the year in the pursuit of higher prices.”

Energy specialists are split on where the market is headed. One camp argues that today’s slowdown is temporary and that global oil supplies will remain constrained for years. When growth picks up again, in this view, so will prices.

Another camp contends that the current slowdown heralds a lasting shift in consumption patterns as consumers trade their gas guzzlers for smaller cars and businesses find ways to use less energy.

Perhaps the biggest question is whether oil prices will drop enough to give consumers some relief, while at the same time remain high enough to call forth new supplies, spur investment in alternative fuels and encourage consumers to use energy more efficiently.

Oil prices have typically tended to stabilize for long periods — when adjusted for inflation, prices look like flat lines for years on end. In the 1990s, a period when supplies were plentiful, prices hovered around $20 to $25 a barrel. But it is unclear where today’s market will find stability, with forecasts of the near-term price ranging from $90 to $150 a barrel.

“The market is still trying to find an equilibrium,” said Michael Wittner, the global head of oil research at Société Générale, in London. He predicts oil will bottom at $105 a barrel in September, before rebounding next year to $120 as supplies remain tight. “Prices need to remain, quote-unquote, high, to continue to limit growth in demand.”

Oil consumption has been falling in all major industrialized countries, including the United States, Japan, Germany and Britain. Sales of big cars and trucks have plummeted, airlines have trouble filling their seats and drivers are making fewer trips.

Gasoline prices, which rose to a nationwide average of $4.11 a gallon last month, now average $3.69 a gallon, according to AAA, the automobile group. The prices have forced many consumers to cut their spending on other items.

Americans drove 12.2 billion fewer miles in June than in June 2007, a drop of 4.7 percent, according to the Department of Transportation. Between November and June, total miles driven dropped by 53.2 billion, the steepest decline registered in a century of data collection, said Doug Hecox, a spokesman for the department.

Gasoline demand is declining as a result. Consumption has fallen for 27 consecutive weeks and is down 2.5 percent since the beginning of the year, said Michael McNamara, the vice president of MasterCard Spending Pulse, who tracks retail gasoline sales nationwide.

“It’s really when prices surpassed the $3- to $3.15-a-gallon threshold that we began to see a steady erosion in demand and consumers changing their behavior,” Mr. McNamara said.

Now that gasoline is falling from its high, however, analysts are wondering whether that trend will turn around. The oil shocks of the 1970s and 1980s led to surging prices and sharp cutbacks in consumption. But they were followed by a long period of low energy prices, and as a result, consumption rose again.

“We’ve been there before, in the late 1970s, and the question is will we be there again if the price crashes,” said Lee Schipper, a transportation expert and visiting scholar at the University of California, Berkeley.

Because many developing countries subsidize their energy costs, preventing them from rising too much, falling demand in the industrial world will be more than offset by growth in emerging markets like China and the Middle East. Global oil consumption is still expected to grow by about 1 percent this year, or 790,000 barrels a day, according to the latest forecasts by the International Energy Agency. That is half of the rate of growth in demand during the 1990s.

“We still have not seen clear signs of slowing demand in the emerging-market economies; however, we believe these signs are still to come,” said Mr. Crandell, of Lehman. “It won’t be negative demand, but these countries will slow to a more restrained pace.”