Who said crude wouldn't drop below $60/bbl?

Bob Tippee

Here's an assignment for anyone who has at any time this year declared that the price of crude oil would never again fall below $60/bbl.

Find a legal pad and a pencil, and write this sentence 500 times: Oil prices can't rise forever.

If the statement still seems questionable, write it 500 times again.

The price of West Texas Intermediate crude fell below $60/bbl last week after reaching $75/bbl at times in July and August.

Suddenly, instead of asking how high the crude price might go, people are wondering about the bottom.

Does a 20% price drop in 2 months' time constitute a collapse? If not, it's certainly the grad-school version of what economists refer to as "a correction."

Whatever you call it, the price drop should surprise no one.

A coincidence of extraordinary influences elevated crude prices earlier this year: low levels of idle production capacity, failure of production outside the Organization of Petroleum Countries to come on stream as expected, unusual strains in key product markets, geopolitical pressures, hurricane fears.

Several of those pressures have eased. And demand has relaxed seasonally in the US and other important markets. Prices are dropping. What else can they do?

So where's the floor? The answer to that question depends on two forces.

One of them is demand, which has wobbled under the weight of high prices but still has structural support from economic development in Asia and India and developed-world prosperity. The other critical force is the unpredictable price that elicits real production cuts, as opposed to talk about the subject, from OPEC's most important producers. That price will be the level at which revenues from unadjusted production become too low to sustain national budgets.

So there is a floor, and it's probably higher than the floor level of the last price collapse—or correction, as the case may be. Maybe it's much higher.

But for anyone who risked money on the proposition that the crude price would never again fall below $60/bbl, the difference between a floor of $40/bbl and one of, say, $30/bbl might now not matter very much.

(Online Oct. 6, 2006; author's e-mail: bobt@ogjonline.com)

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