Oil

The Oil Price Bubble Bursts

And prices are falling a dollar a day

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Oil prices have dropped by 60 percent since July. And they fell without the benefit of a gasoline tax holiday, new anti-speculator regulations, or a windfall profits tax on oil companies. A year ago, crude oil was going for $88.00 per barrel and gasoline cost an average of $2.76 per gallon. Over the following months, the price soared, reaching an inflation-adjusted record high of just over $147 per barrel in July. Then the bottom fell out. Yesterday, the price was hovering around $58, up from a recent low of $53 per barrel. The result is gasoline prices plummeting from a national average of $4.11 per gallon in July to below $2.07 per gallon now. So what happened?

First, just as one would expect, higher prices led to lower demand. U.S. demand for petroleum in 2008 was 5.4 percent lower than in 2007, falling by 1.1 million barrels per day (bpd) from 20.7 million to 19.6 million barrels per day. As prices rose Americans curtailed their driving. The Federal Highway Administration reported that in August 2008, Americans drove 15 billion fewer miles, or 5.6 percent less, than they did in August 2007. On the other hand, recent high prices have called forth new sources of supply. For example, Canadian oil sands now produce 1.1 million barrels per day. And new deepwater offshore production rigs like the Thunder Horse (250,000 barrels per day) and Tahiti (125,000 barrels per day) platforms are coming online. Falling demand and increasing supply mean lower prices.

In addition, a good portion of the lower demand for oil is the result of the global economic slowdown. "This time the usual petroleum boom/bust cycle lined up on top of the business cycle," said Tim Evans, an energy futures analyst at Citigroup's Futures Perspective. In March 2008, Evans warned that we were in the midst of a bubble and that oil prices would drop. When the investment firm Goldman Sachs suggested the possibility of $200 per barrel oil, Evans predicted that prices would fall to $60 to $70 per barrel. He observed presciently that "this is the riskiest time to be long in crude oil since 1980."

So as prices drop will demand increase? Yes, but Evans believes that U.S. demand will rise slowly. Why? In part because various federal government policy responses to recent high oil prices are unlikely to be reversed. For example, the Federal government has mandated that Corporate Average Fuel Economy standards for automobiles rise from 27.5 miles per gallon now to 35 miles per gallon by 2020. Evans thinks that hybrid automobile technology may look economically attractive even at current prices. Plug-in hybrids like the Chevy Volt should use about 2 cents of electricity per mile compared to 12 cents per mile of gasoline. In addition, Evans says, "The biofuels initiatives aren't going to go away. Even if they are not economically smart, the votes are there to make sure that we stick with these programs." So subsidized biofuels will displace some demand for gasoline, putting downward pressure on the price of crude oil.

On the supply side, those "windfall profits" that oil companies have been earning in the last couple of years are paying for exploration and development of more oil supplies. It is true that the oil companies have been using their record profits to buy back stock and thus increase shareholder value. Some members of Congress believe that the oil companies should spend their profits on alternative energy projects that the companies don't believe can be justified economically. And if the oil companies don't stop enriching their shareholders, Congress will see to it that the "windfall profits" are taxed away and spent by government bureaucrats on alternative energy projects. It is possible that the members of Congress know better how to spend oil company profits than do their executives, but the Federal government's record in this area is not impressive.

Naturally, suppliers don't like lower prices, so the members in the Organization of Petroleum Exporting Countries (OPEC) want to drive up prices by restricting supply. In October, OPEC members pledged to cut oil production by 1.5 million barrels per day beginning on November 1. They plan to hold another meeting later this month to discuss further reductions. Even as consumers enjoy lower prices at the gas pump now, analysts at the International Energy Agency fret that they will lead to underinvestment in oil production capacity, resulting in a crude oil supply crunch by the middle of the next decade. Disturbingly, 80 percent of the world's known oil reserves are owned by government oil companies whose revenues are looted rather than reinvested in production. In any case, lower prices and the credit crunch are already causing oil companies to shelve some projects. Alternative energy promoters also fear lower petroleum prices because they make their projects even less economically feasible. Some are advocating a higher gasoline tax in order to counteract the deleterious effects of lower crude oil prices on the glorious alternative energy future.

So what's next for oil prices? For the coming year, Evans thinks that the price of oil will bounce around in a trading range of $50 to $90 per barrel, averaging around $70 per barrel.

Ronald Bailey is reason's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books.

Disclosure: Yes, I still own those 50 shares of XOM that I bought with my own money. The shares are down 12 percent from their high this year.

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  1. Oil prices have dropped by 60 percent since July, writes Science Correspondent Ronald Bailey. And they fell without the benefit of a gasoline tax holiday, new anti-speculator regulations, or a windfall profits tax on oil companies. So what happened?

    Did not RTFA but I’m gonna take a wild uninformed guess. Sine Saudi sized oil fields have not come on-line in the last 6 months, I’m gonna guess … Lower demand?

  2. Sine = Since.
    My bad.

  3. Three causes:
    1. The run up was speculative.
    2. The financial crisis popped the bubble.
    3. New production came online.

  4. Uh, hello!!! The terrorists heard our “drill here, drill now” chant and reduced the price of oil. They know that America has enough oil to kick some terrorist butt.

  5. Prices are just like the rain and the sun–all just natural things that don’t need any government interference. Relying on the horrible state is like using a condum or other form of birth control–it’s against nature and natural law!

  6. In the town where I get gas on the way to work, it’s at $1.97. I honestly thought we’d never see it get below two bucks again.

  7. “And if the oil companies don’t stop enriching their shareholders, Congress will see to it that the “windfall profits” are taxed away and spent by government bureaucrats on alternative energy projects. It is possible that the members of Congress know better how to spend oil company profits than do their executives, but the Federal government’s record in this area is not impressive.”

    I have yet to hear any of these Congressmen explain why it is any more the responsibilty of the big oil corporations to finance some alternative energy scheme they dream up than it is for any other corporation such as Proctor & Gamble, Microsoft, etc.

    Exxon is in the oil and gas business. They are no more obligated to develop wind or solar power (or anything else) than any other entity is.

    Any alternative energy source that is REALLY all that viable should presumably be able to attact enough investment capital to get it developed independently of the “Big Oil” corporations.

    And if the policitians claim some scheme is a “public good” then they should quit pussyfooting around about it and directly put taxpayer money (and their neck) on the line for it instead of trying to sneak around and do it through the back door with windfall profits taxes or mandates on “Big Oil”. Because those mechanisms would essentially impose at tax on everybody as well. It just wouldn’t be called that.

  8. I agree, sage. I was very pleased to feed the Massive Pickup $1.84 gas yesterday.

  9. I await Congressional demands that consumer windfall ‘profits’ resulting from no longer having to pay over $4 a gallon be disgorged to support the struggling oil companies.

    (Meanwhile, the price of a gallon of regular here in North Texas is hovering around $1.80)

  10. I wonder what will happen to the governments that depend on high oil prices.I doubt they saved or invested much,take Russia and Iran for instance.Could be interesting.

  11. True, Michael. Venezuela has to be hurting bad right now.

  12. filthy supply & demand non governmental interference…when will we learn that the government should control every aspect of our lives, without question?

  13. Don’t some of these price swings also have to do with changes in the value of the dollar?

  14. I hope you libertardians spend all your pump savings on hookers and blow.

  15. In my circle, I called the oil bubble – but there’s no way that demand is the only thing causing this commodity to tank. It’s more or less that it was more inflated than most analysts were willing to admit.

    I’m waiting for the prices of positively everything else to come down because the cost of oil has come down, since every company under the sun used high oil prices as a justification for raising them.

  16. Its interesting to note that deliveries to the Strategic Petroleum Reserve were finally halted in July – at the peak of crude prices. Often an oil man’s best friend is the government.

  17. Just got out of alcohol rehab and the price of gas fell $1.60 in 28 days.
    That’s pretty sweet.
    Made the drive home worth it. Plus the fact that I got sober.

  18. Congratulations, JK.

  19. There’ll be time for Obama and the Democrats to do something about these outrageously low gasoline prices come February, like imposing an extra $1 to $2 per gallon tax on gasoline at the retail level.

    This will guarantee that they hold onto their power for eternity, because all working Americans hate this cheap gasoline and are desperate to pay higher taxes, especially in an economic downturn.

  20. Let’s see, shrike. The SPR was filled at a rate of 60,000 barrels per day, which caused this huge increase in the price of crude oil. OPEC is about to cut production by over ten times that much, yet oil futures aren’t going up to their peak levels. Why?

  21. It’s because of DRILL BABY DRILL!!!!!

  22. 1. The dollar has gone up.
    2. Demand has fallen because of the global recession.
    3. Demand for gas is inelastic as hell but not totally inelastic. It will fall with higher prices and did fall. The flip side of that inelasticity is that demand doesn’t rise as fast when prices fall. That is why oil is a boom bust commodity.

    Not to gloat, but I will, when oil was at $140 and all of the “peak oil” degenrates were on here cyring doom doom doom, I said the price would bust. It always does.

  23. I said the price would bust.

    Ron Bailey had also been making the same predictions.

    So, let me be the first to predict that after the price of oil bottoms out, it will go up again.

  24. Just got out of alcohol rehab and the price of gas fell $1.60 in 28 days.
    That’s pretty sweet.
    Made the drive home worth it. Plus the fact that I got sober.

    What, no profanity? Seriously though, congratulations.

  25. I was referring to the extra $9 billion put into the coffers of the oil companies, J-D. ($90 x 100 million bbl over and beyond today’s spot price) and removed from the taxpayers wallet.

    I am well aware of the speculator’s effect on oil prices during the spike.

  26. “So, let me be the first to predict that after the price of oil bottoms out, it will go up again.”

    It sounds incredibly simple and it is. Sadly, the idea that high prices do not sustain themselves for very long without some kind of artifial support is a hard concept for some to grasp. There are lots who were claiming it would never go down that the “age of cheap oil was over”.

  27. Sounds like the oil companies need a bailout.

  28. “…high prices do not sustain themselves for very long without some kind of artifial support…”

    “Artificial support”, you say?

    Enter Comrade Obama, stage left with a global warming carbon tax scheme.

  29. Jamie, if you’re sober, it means I’ll have to get wasted more to cover for you. I’m not complaining.

  30. So, let me be the first to predict that after the price of oil bottoms out, it will go up again

    And let me predict that the currently silent leftist demogogues in D.C. will resume their blathering about taxes and controls and dire punishments as gas prices inevitably rise again next spring.

  31. I think some of the gas savings have also come from a shift in families’ driving habits.

    For example, the family that has a suburban and a sedan. Previously, whenever the family decided to go somewhere, everyone would pile in the big car, even if there were enough seats in the smaller one. Once the pricing got high enough, people started making a point of taking their more fuel-efficient option wherever possible. So everyone squeezes into the Civic unless you absolutely have to take the Suburban. That’s going to amount to a good 5%-10% fuel savings for many families right there without reducing the total number of miles driven, or having to go out and replace a gas guzzler.

  32. Congrats Jamie. Just don’t start apologizing for shit.

  33. I’ll just quote the husband of the future Secretary of State:

    It’s the economy, stupid.

  34. Just don’t start apologizing for shit.

    Jeez. I thought I was the unsweet one.

  35. I eagerly anticipate (as D.A. said earlier) President Obama pushing for a “windfall consumer profits tax” to recompense the evil consumers for greedily taking advantage of low prices.

  36. I eagerly anticipate (as D.A. said earlier) President Obama pushing for a “windfall consumer profits tax” to recompense the evil consumers for greedily taking advantage of low prices.

    Isn’t that what the tax increase is for?

  37. Jeez. I thought I was the unsweet one.

    WhadIsay? I don’t think I could take a “nice” Jamie.

    On point though, 2 of the stations near me are having an honest to god price war. It’s fucking glorious.

  38. I’d like to quibble with Bailey’s point that stock buybacks create shareholder value. It doesn’t raise the market cap or improve the ROI. It just reduces the number of shares outstanding and raises the stock price.

    By the way, I would hardly call oil in the 50s low. It would still represent a 40% premium over oil in 2004, in the face of a recession. It’s also a 100% higher than prices were during the last recession in 2001/2. Exxon Mobil execs would be very happy if oil stuck around in the 50s.

  39. I agree with Mo about mid-50s not being “low”. If it gets back into the $10-$20 range, then it will be “low”.

  40. sage touched on a good point – for those bitching about the “outrageous” profits of oil companies, note that they are not among those companies blubbering to Congress about being “too big to fail”.
    I won a steak dinner betting gas would be under $2 by the end of year back in June.
    I also know that OPEC production cuts will have no effect on oil prices. History is on our side here, most OPEC countries (Think Iran and Venezuala specifically)vociferously fight for production cuts – and then cheat once they are implemented.

  41. I’d like to quibble with Bailey’s point that stock buybacks create shareholder value.

    It creates shareholder value for shareholding executives, and increases the value of their options. And that’s what’s important.

  42. BDB & Mo: I didn’t say prices were “low,” I said they were “lower” and that the price bubble had burst. As I’ve written before, I am worried that incompetently run government-owned oil companies will keep prices higher than they would otherwise be for the foreseeable future.

    P Brooks & Mo: Buying back stock pays off shareholders who want to sell at the current price and tends to increase the value of stock the rest of us hold. It is true that it makes the stock options of corporate officers more valuable too.

  43. most OPEC countries (Think Iran and Venezuala specifically)vociferously fight for production cuts – and then cheat once they are implemented.

    Just like US farmers on ag subsidy quotas.

  44. “I was referring to the extra $9 billion put into the coffers of the oil companies, J-D. ($90 x 100 million bbl over and beyond today’s spot price) and removed from the taxpayers wallet.”

    Got it.

  45. Why did prices come down? Summer ended. Duh.

  46. Exxon Mobil execs would be very happy if oil stuck around in the 50s.

    XOM is not a well run company. I think a sustained price level of 50 bucks is as problematic to them as a sustained price level of 100 bucks is to most airlines.

  47. Thanks guys.
    Never thought sobriety would be so … nice.
    And by the way, I don’t plan on apologizing for anything, and there’s no way I’m going to be fucking nice, especially with a giant cock with big-ass ears in the fucking White House for the next four shit-stained years.

  48. So has Obama taken his “tax the oil companies profits to fund alt. energy research” plan off the table? Or was that Pelosi? I can’t remember, they look so much alike lol.

  49. Epi —
    Drink ’em in my name. I’ve fallen down enough for the both of us.

  50. For all you consumers who want to lock in the current low gas prices: Buy an appropriate amount of gasoline futures, as far out in time as you can. Then you can use the profits from this speculation, to offset any increased fuel prices if the price goes up. This is how Southwest Airlines has managed to control its fuel costs, to its competitive advantage.

  51. I won a steak dinner betting gas would be under $2 by the end of year back in June.

    You should have bought DUG. There’s a lot more steak dinners there.

    XOM is not a well run company. I think a sustained price level of 50 bucks is as problematic to them as a sustained price level of 100 bucks is to most airlines.

    XOM had a net income of 9% of revenue when oil was trading in the 20s and 10% in 2005, when it was trading in the 50s. When you include all the fields they would develop once they saw a sustained $50 price. XOM would be sitting pretty.

    Ron, I wasn’t criticizing you for saying low, but everyone that were patting themselves on the back for predicting oil to drop from its peaks. When oil rose to $50/bl, it was a pain in the ass too. It’s bearable, but I’d be a lot happier with oil at $20/bbl

  52. I didn’t RTFA either but I’m sure J sub D nailed it in the first comment.

  53. Jamie Kelly | November 18, 2008, 4:04pm | #
    Thanks guys.
    Never thought sobriety would be so … nice.
    And by the way, I don’t plan on apologizing for anything, and there’s no way I’m going to be fucking nice, especially with a giant cock with big-ass ears in the fucking White House for the next four shit-stained years.

    Welcome back Jamie!!!

  54. “Prices are just like the rain and the sun–all just natural things that don’t need any government interference. Relying on the horrible state is like using a condum or other form of birth control–it’s against nature and natural law!”
    Uh, did you even read the article?

  55. Behold, the great Obama has caused oil prices to fall!

  56. Jamie Kelly went through alcohol rehab?

    Maybe I should consider that myself…

    Nah! I’m gonna down me a few more shots.

  57. “Jamie, if you’re sober, it means I’ll have to get wasted more to cover for you. I’m not complaining”
    Don’t worry, Epi, already got it covered.

  58. 1) Congrats to Jamie!

    2) I’m buying a Prius anyway this spring. Oh yes, I am. Why? Because Murphy’s Law says that if I do this then either the price of gasoline will never, ever rise ever again, or else the day after I buy it they’ll come out with a 100 mpg car and then all these people will annoy the shit out of me by reminding me that I should have waited. To which I’ll be able to reply that were it not for Murphy and my Prius their 100 mpg car would not exist.

  59. If gas/carbon taxes replaced existing taxes, I’d be for it. Of course they never do, they just add to government revenue. But still, it’s a worthy policy goal to wean the country off ME oil, and consumer taxes are a great way to do that (and infinitely more efficient than CAFE standards).

    But since I’m probably preaching to the choir here, allow me to post this nauseating video of Bill Moyers on climate change, punctuated by a heroic moment 14 minutes in, when Mitch McConnell ordered the climate change bill to be read in full, which took 10 hours =D

  60. I’m an armchair economist, so am I right in saying the author obviously doesn’t understand the nuances between “demand” and “quantity demanded”?

    The EIA apparently understands.

  61. Maybe that’s what I should rename myself.

  62. Not to gloat, but I will, when oil was at $140 and all of the “peak oil” degenrates were on here cyring doom doom doom, I said the price would bust. It always does.

    Anyone taking bets on July 2008 having been peak oil? It is a distinct possibility. Production is down, and will remain so for as the recession lasts. When the economy finally turns around a year or more from now, it is not going to be a matter of just opening up a few of the closed spigots. Oil production rates from already-utilized fields are falling faster than ever, and discoveries of new oil are falling faster than ever. Since a price on carbon is essentially inevitable now, “unconventional” oil such as Canadian tar sands will not be economic until the price hits much higher levels…at which point we won’t even want to bother because the alternatives will be cheaper.

    Oil will start going up when the economic situation sorts itself out…and despite some blips and burps, the trend is clearly going to be in only one direction. You just can’t escape the reality….there is only so much oil remaining, most of what is left is hard to drill and low grade, and worldwide demand is going relentlessly upward.

  63. Jamie Kelly | November 18, 2008, 4:04pm | #

    Thanks guys.
    Never thought sobriety would be so … nice.
    And by the way, I don’t plan on apologizing for anything, and there’s no way I’m going to be fucking nice

    I’m sure they have a rehab center for that somewhere too.

    🙂

    i kid

  64. Gasoline is cheaper now because of the heroic efforts on behalf of us worthless scum by the great mother-godess Nancy the Pelosi.

    Pray to her because prayer changes things.

    I don’t really believe in the Law of Supply and Demand btw. I hope Nancy will soon go to work on the Law of Gravity.

    Bill Walsh

  65. Congrats, Jamie. I for one am looking forward to your, uh, observations over the next four years.

  66. Chad,
    We know that. So, since the price of carbon-emitting fuels is only going to go up (and thus the quantity demanded will go down), I guess there’s not too much need to worry over greenhouse gases, right?

  67. Oh, right, the price still won’t rise fast enough. Anything that can work itself out works itself out better with government intervention.

  68. Since a price on carbon is essentially inevitable now, “unconventional” oil such as Canadian tar sands will not be economic until the price hits much higher levels…at which point we won’t even want to bother because the alternatives will be cheaper.

    I think this is a way of saying that we can make damn sure July 2008 was “peak oil” via government intervention in the form of carbon taxes or cap ‘n’ trade or whatever, yes?

  69. We’re forgetting Greenspan’s wisdom. We should be thankful for his farsightedness and his amazing fine tuning of the markets. Only ignorant fundamentalists will claim that oil’s price has been driven by gov’t intervention and money counterfeiting by the Fed…

  70. The reason for the drop in oil prices is not because demand has for oil has fallen….a 9% drop in worldwide demand does not equal a 68% drop in the price of oil, particularly because of the relatively inelastic demand for oil. The real factor at work is the growth rate of the money supply, which, despite a lot of hot air from a lot of people, is actually declining. Leverage and loan growth essentially create money supply, but the de-leveraging of the financial markets coupled with the lack of credit to consumers and businesses has dampened any money supply growth that we could have expected from the bailouts and the Fed interest rate reductions.

  71. Ron,

    I read an article in EDN and it turns out it costs more to run a vehicle on electricity than on oil if you pay 22? a kWh for electricity.

    EDN on the price of electric transport.

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