Recession Fears Will Bring Oil Down to $70

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As shown in the grgaph above, both oil (blue line) and gasoline (red line) prices have surged over the past five years. However, oil prices have about tripled, while gasoline prices have only done a little more than a double. The prices of these two commodities were tracking together quite closely until around June 2007. Since June, however, gasoline prices have remained relatively stable, while oil prices have continued to rise.

Last week, oil broke above $100 per barrel. Speculators are getting much of the blame. The divergence between oil and gasoline prices gives some credence to this theory. After all, looking strictly at supply and demand considerations, it is difficult to understand why oil prices have gone up so high. While it is certainly true that oil-producing regions of the world are not very stable, and that the world is consuming all it produces, there are no shortages.

As today's numbers show, the economy is no longer producing a sufficient number of jobs. The unemployment rate jumped to 5%. The U.S. economy is slowing and the probability of recession has risen significantly. While gasoline prices may go up in the short run, it is much more likely that an economic slowdown will cause oil prices to fall over the longer run. Look for oil to drop to $70 per barrel this year.

Comments

[megiddo666]

Appreciated your thoughts, however there are a few factors that may change the assumptions.

Chinese private vehicle ownership in 2007 was up 10.92 percent over 2006. Trucks ownership increased 7.5%. China added 15 million new drivers in 2007. China will build over 2000 miles of new interstate highways in 2008, not including new provincial highways and will still not have completed its national highway system. Chinese new car sales are expected to be increase around 20% yoy in 2008.

The Chinese are already experiencing long lines at gas stations, and trucks are rationed diesel purchases in many cities and provinces. China is still expanding its national petroleum reserves.

This demand problem is not one that will be solved soon. This does not consider increased oil use elsewhere, outside the US and Europe.

On the supply side, OPEC is not increasing production and has stated high oil prices will continue through 1Q 08.

Given the above, I would expect gas prices to rise to meet oil costs as much as oil prices to decline.

2008 Jan 06 12:33 PM

[Greg Pinelli]

While it's difficult to know how deeply a recession would cut into the oil price (US? North American? China?..in other words..What are the parameters?) I wouldn't becessarily argue with a pullback to $70-80..
That said....gasoline may or may not track oil...that's as much a refinery as a crude supply issue. When gasoline does change price it will surge..and driving less is the last option anyone anywhere will entertain.
Oil is at $100...because there is less of it..and demand is either steady or increasing. The world has not increased daily output in any significant way in 3 years! Political unrest and speculation exist at the margin..and are really scapegoats..In fact..I'd be willing to argue that if peace broke out in the Middle East people would begin driving so much that oil exports would actually decrease.

2008 Jan 06 06:52 PM

[erniem]

Oil prices reflect perceived and real supplies and shortages. The simple fact is that a limited supply is available and yearly consumption continues to grow. Even if consumption dropped 5% a year ( unlikely) the supply is still measure in decades left, not centuries. In other words, forty years from now we won't be discussing whether oil will be at $70 or not. We will be discussing whether the $300 oil supply is large enough to supply lubrication for machinery and infrastructure.

2008 Jan 07 12:13 PM

[Ronmac]

If it does go down to $70, I would advise mortgaging the house to buy it..

2008 Jan 07 01:54 PM

[AAS]

Let's be realistic.......the demand for oil increases expotentially while the supply of oil does not. Gasoline vrs. crude oil is only a part of the picture....after all crude oil contains many compounds that are part of various manufacturing processes.........i.e. resins for plastics, solvents etc. etc. Dream on.....dream on.....the world is changing, simple wishing will not change it.

2008 Jan 07 06:26 PM

[misterchan]

I agree with Ernie Montague. For instance, I remember when See's chocolates were $1.20 per lb. That was in 1946. And if you bought a pound, it did not seem like a bargain. Today, this same item sells for over $14.00 per lb. The descent of the dollar has been underway for a considerable time. $100 for oil is, in the minds of many, a resistance point. Round numbers have that effect. But just as soon as oil is $105.00, the round number will be unimportant. And the reality that the price of oil, along with a lot of other things, is destined to go much higher, will be an accepted fact.

2008 Jan 07 07:07 PM

[hugho]

Vahan's comment of oil price heading to $70 is an unlikely scenario for some of the reasons posted above. For an exercise take a blank sheet of paper, draw a vertical line. Left column is factors driving oil price down, right column factors driving price up. The factors in the right column are myriad. The obvious left column entry of a recession tamping demand is the only dominant factor I can come up with. There are others but oil is a different commodity. It is not chocolate or wheat or pet food. Production is inelastic. If oil goes to $70, not only will I mortgage my house but I will sell the furniture on ebay to raise cash!

2008 Jan 08 10:05 AM

[Ames Tiedeman]

Well, this guy is about 80% wrong. Oil is now 126

2008 May 18 08:27 PM