Where are Oil Prices Heading?

At OPEC’s most recent meeting held in December, the thirteen-member cartel agreed to reduce crude oil outputs by 2.46 million barrels per day, a record production cut for the group. As world crude prices dropped below $38/barrel, the cut is designed to stabilize prices to meet OPEC’s forecast of $75/barrel as “fair.”

Market analysts believe that the OPEC production cut is likely to fall short of the intended spur to $75/barrel. Among others, Morgan Stanley joined those whose world forecasts predict significantly lower prices in the $25 – $30 per barrel range.

Producers such as Saudi Arabia and the United Arab Emirates could maintain budget equilibrium or surpluses at the $25 price level. Less stable political bodies, such as Iran, however, could easily foresee increased borrowing requirements in light of continuous dropping world demand and a shortfall of oil revenues.

Russia, a non-OPEC member, hinted that it might support cuts of its significant domestic production if the worldwide economy does not recover to increase oil demand.

China cut prices on refined product, such as gasoline by 13.8% and diesel 18%, to stimulate its domestic economic demand.

India, with its large subsidized oil sector, nearly 70% import-dependent, cut its retail fuel prices. It continues with its political objectives of conservation, alternative energy, and strategic domestic reserves.

The recent economic roller-coast activity in the gyrating world-wide demand for oil points out one of the fundamental “truths” of economics.

When finite supplies of a product in world-wide high demand and only limited substitutability exist, cartels are a natural phenomenon. That is as true for sugar, coffee and many others as it is for oil … or drugs..

If cartel members agree on pricing policies and various political issues, cartels can remain effective for decades and longer.

That is certainly true on the supply side of the equation.

Less effective is potential manipulation of demand.

There is little OPEC can effectively do to stimulate economic demand that the market itself cannot.

Further, as actual substitutability for oil is demonstrated through the application of alternative energy sources, demand for oil is likely to decrease further.

The leadership of OPEC is economically savvy and understands the economics. It also understands the ills of short-term gratification at the expense of long-term satisfaction.

Whether the current financial worldwide crisis equally enlightens the American consumer remains to be seen.

The potential collapse of the automotive industry (as we know it) should give rise to a new, fossil-fuel-free base of employment.

It automatically generates expanded opportunities for research and development of existing and new technologies in every conceivable field of scientific and commercial application.

Will the average American consider the high levels of crude oil earlier this year and its subsequent fall as a xenophobic and conspiratorial plot?

Perhaps the public will finally understand the machinations of supply, demand and the effect of cartels?

Supply shocks and price increases occasioned by cartels are likely to recur in the near future if the world’s dependence on oil is not carefully checked. Most of that stems from the demand side of the formula!

OPEC’s next regular meeting is scheduled for March 15, 2009, in Vienna, Austria.  It will precede the OPEC International Seminar on March 18-19.

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