The Current Oil Price Picture

There must have been a sigh of relief from inflation watchers as oil prices fell to $63/barrel on September 7. Prices have been declining steadily for a month despite continued tension in the Middle East and the steady “fear factor” drum beat of last few weeks.

The recent drop in oil price by as much as $10/barrel is a result of classic short term supply-demand interplay—swelling stockpile of crude oil relative to softening demand resulting from the end of the summer driving season in the U.S. and major industrial economies. The supply picture was further improved by resumption of loading of oil tankers in Nigeria as the dock strike was settled. The cessation of hostilities in Lebanon certainly had a positive effect on oil prices in the last two weeks.

According to the U.S. Energy Information Administration (EIA), the current drop in crude oil prices is unlikely to be sustained into the next year and crude oil price will average $70/barrel in 2007. The underlying assumption for this likely scenario is: supply will not keeping up with rising demand. On the supply side, the expectation is that there will not be much increase in oil production capacity next year. Most of that increase will come from Saudi Arabia.

The oil price situation is unlikely to change in 2007 unless Middle East tensions are significantly reduced and OPEC turns on the oil spigot further. Oil prices will continue to fluctuate in the range $65-$75 range for the next 12 months with the ebb and flow of problems in the Middle East and supply uncertainties related to it.

Longer Term Oil Picture

There is some good news on the energy front—-the recent discovery of a huge oil field (deposit of ~15 billion barrels) very, very deep (7,000 feet underwater and an additional 20,000 feet below the sea floor) in the Gulf of Mexico by Chevron and its partners. This is an extraordinary technological achievement by one of the leading oil companies of the world. The newly discovered Mexican oilfields will undoubtedly increase U.S. oil reserves.

The challenge, however, is that it will be years before oil production will materialize from this field. Furthermore, it will only make a relatively small impact on the U.S. energy picture with its daily production of 800,000 barrels a day—a small fraction of the U.S. daily oil consumption. (Cambridge Energy Research, Cambridge, Mass.)

With the U.S. as the world’s largest consumer and importer of oil (60 % of U.S. consumption is met by imports that come mostly from highly unstable and dangerous places), this technologically impressive oil strike in the Gulf of Mexico should not lull us into complacency.

I agree with President Bush when he says that we are addicted to foreign and we should lessen our dependency on it. The question is how should we do this? To be serious about this goal we need to do more than just prospect for oil. We as a nation should increase our efforts toward more intensive development of renewable energy sources, continue to enhance energy conservation, and work on greater fuel efficiency in our transportation sector.

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