On May 6, 2008, NYMEX crude oil futures were trading at $122.49 per barrel, and Goldman Sachs was predicting prices between $150 and $200 per barrel within 2 years. I pronounced it a speculative bubble and predicted crude oil would trade below $100 by the end of 2008 and below $70 before the end of 2009. The price topped out at $147.27 on July 11 and today traded as low as $68.57.
Experts were saying burgeoning demand in China would drive prices higher even if demand in the developed world were stable. I thought crude oil prices in this range would not only destroy US gasoline demand but would throw the whole US economy into a tail spin, and that that would drag down the worldwide economy. The situation reminded me of 1981. Then, crude oil prices spiked to about $90 (in 2007 dollars), the economy collapsed, and crude oil prices quickly followed. I recognized that the US economy is only about half as energy intensive now as in 1981 and that the US economy is a smaller fraction of the world economy now. Still, I felt pulling over $0.5 trillion out of the US economy every year to pay for imported oil would severely injure other parts of our $14 trillion GDP.
I was also persuaded that the high prices were not being driven by supply/demand fundamentals so much as by speculators piling into commodities as a hedge against the falling dollar and as a pure gamble. Finally, I felt the Saudis and some other Gulf States were worried about short-term demand destruction and in the longer term actions by their customers to use oil more efficiently and substitute other energy sources.
I think I was right about all those factors, but I did not anticipate the financial system meltdown, which I think has probably been a very big factor as investors have scrambled out of commodities futures to reduce leverage and to try to get ahead of a deep worldwide decline in the prices of all asset classes.
The next question is what is the price range the Saudis want to try to defend. My guess is $70-80, but it might be as low as $50. Others, like Russia and Venezuela, are lobbying for a $100 floor, but I don't think they'll get agreement there. At $70 and recently reduced demand levels, the US would still be transferring about $0.3 trillion per year to oil producing nations. That's like paying a 2% sales tax on all US economic activity to "people who don't like us very much" (quoting John McCain). We need to reduce that outflow substantially by reducing demand for petroleum. Bring on higher CAFE standards and electric vehicles. Please.
Skeptic
The Saudis are reported to think a price of $70 per barrel is about right, according to an IMF official. This Bloomberg report also estimates the minimum prices selected producing nations need to avoid budget deficits.
Skeptic
This is how cartels lose control. Russia says it will not reduce petroleum production even if OPEC does, and that Russia will proceed to increase productive capacity. Petro states that are highly dependent on oil revenues to balance a national budget tend not to reduce production when prices decline and to increase production when prices rise, as would be predicted by classical models of perfect markets. In fact, they tend to do the opposite because they are not primarily profit maximizers but government budget balancers.
Skeptic
OPEC met yesterday and left output quotas unchanged, "banking on a recovery of oil demand toward the end of this year" and trying to avoid stressing the economy with higher oil prices, according to this NYT report.
“The market is oversupplied, it’s true,” Abdalla Salem el-Badri, the OPEC secretary general, told a news conference afterward, saying the group had decided against cutting output to avoid sending the “wrong signal” and disrupting an economic recovery. “If we are able to keep this $60 to $70 price for the remainder of the year, it will be fine,” he said in a Bloomberg Television interview.
