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September 15, 2006
Will Gas Prices Continue Tumbling?

As I drove home from work yesterday, I noticed that local gas stations now sell regularl unleaded at $2.17 per gallon, a level I have not seen in many months, perhaps before Hurricane Katrina took a large part of our production off line. Now analysts predict that oil prices may start a free-fall if the winter proves mild, perhaps sending pump prices to levels not seen in years (via Power Line):

The recent sharp drop in the global price of crude oil could mark the start of a massive sell-off that returns gasoline prices to lows not seen since the late 1990s — perhaps as low as $1.15 a gallon.

"All the hurricane flags are flying" in oil markets, said Philip Verleger, a noted energy consultant who was a lone voice several years ago in warning that oil prices would soar. Now, he says, they appear to be poised for a dramatic plunge.

Crude-oil prices have fallen about $14, or roughly 17 percent, from their July 14 peak of $78.40. After falling seven straight days, they rose slightly Wednesday in trading on the New York Mercantile Exchange, to $63.97, partly in reaction to a government report showing fuel inventories a bit lower than expected. But the overall price drop is expected to continue, and prices could fall much more in the weeks and months ahead.

Why will the prices fall so low? It comes from the speculation involved in commodities trading. Over the past couple of years, traders have built a lot of catastrophe into oil prices, betting on future disruptions of serious scale due to bad weather, war, diplomatic difficulties, and bad economic conditions. However, it turns out that most of the risks either have fizzled or were overstated -- and now the market is somewhat flooded in oil.

Demand hasn't really changed much from expectations. China still commands more and more oil as its economy expands through modernization and limited privatization. Iran still may present a major problem to oil supplies, especially if the US gets sanctions imposed. However, China looks more and more unlikely to join in sanctions against Teheran, which means that other sources will not get taxed at any rate near to expectations.

Production has not caught up with this new dynamic. Thanks to the fevered hoarding of traders, production has remained at high levels even as surpluses mount, with the expectation that the high demand and global volatility would keep demand high. Now it looks like the high supply levels will start a tumble that may not stop for several months, as OPEC and other producers wait to see what production levels they need to meet to support pricing.

I doubt we'll see $1.15 per gallon. That's what I paid for gasoline 25 years ago -- and I don't mean that in adjusted-for-inflation terms. The instability in the region during the war on terror will keep the floor higher than that. However, cheaper oil will bring several salutary effects, not the least of which is the lessening of impact that any al-Qaeda attacks on production facilities might have. It will also reduce the partisan politics that currently surround energy prices, perhaps allowing some wisdom in determining a more sane policy for energy independence, one that relies on a massive expansion of nuclear power for electricity.

If the price drops below $2 per gallon, Democrats will have few outlets for their electoral hysteria before the midterms.

Sphere It Digg! View blog reactions
Posted by Ed Morrissey at September 15, 2006 5:36 AM

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