Image: Fuel hose
Joe Raedle  /  Getty Images file
In Boston, Mass., Mike Walsh from Arlington Fuel Oil Co., Inc. hooks a fuel hose up to a pipe as he makes a delivery of heating oil. Lower prices for heating oil and unusually warm weather  have given many homeowners a break on their energy bills.
By John W. Schoen Senior producer
updated 1/9/2007 5:34:20 PM ET 2007-01-09T22:34:20

Call it the energy dividend. After 2006 tore a big hole in consumer’s wallets and took a bite out businesses' bottom lines, a recent sharp reversal in prices may help make up for some of that pain.

A lot depends on where oil prices are headed from here. But the outlook is clouded by a host of forces, including OPEC oil ministers, hedge fund speculators, the strength of the global economy - and the weather.

After peaking at just under $77 a barrel in late August, crude oil futures have plummeted to about $50 a barrel — falling more than $10 in the past month alone. Analysts cite a variety of reasons — from a big inventory buildup last year to slower demand from unusually warm weather this winter. But they’re divided on where price are headed from here — thanks to variety of forces at work that could keep prices from falling further.

This summer’s record prices for crude helped bring increased supplies to market — from both private oil companies and state-owned producers eager to cash in on the surge in price. By mid-November, oil inventories had swelled to 340 million barrels — well above their 5-year average highs, according to the Department of Energy.

“There was real concern here that going into 2007 you were basically running out of places to put the oil,” said John Kingston, who tracks the market as director of oil at Platts, a commodity news and information service.

As supplies were backing up, a slowdown in the global economy helped ease demand. Unusually warm winter weather cut consumption of heating oil and natural gas, sending prices of those commodities lower as well. So homeowners and landlords have gotten a substantial break on their heating bills so far this winter.

Gasoline pump prices have been slower to pull back — a gallon of regular sold for an average $2.33 last week, a few cents higher than early December. Part of the reason is that demand for gasoline remains strong — people still have to go to work, so warm weather doesn’t help cut gasoline consumption. Increased construction activity made possible by warm weather has also added to demand from builders. But pump prices have flattened in the past month, and analysts say they expect prices to ease in the coming weeks.

$20 oil in the next 4 to 8 years?

There a few oil analysts who believe oil prices could be headed for a much bigger fall —especially as heavy investment in new production during the recent price run-up begins to bring a big increase in supplies to market. Even at $50 a barrel, that investment in new production will remain strong, according to Peter Beutel, who follows the oil market as president of Cameron Hanover.

“We will find a lot more at these prices,” he said. "A proven barrel of oil is how much you can get at today’s price. I believe we have a lot more oil on this planet than people believe. And we are going to find it over the next few years."

Beutel thinks oil prices could fall as low as $20 a barrel in the next 4 to 8 years before beginning to rise again.

But while new discoveries are being made, much of the world’s oil today is produced in regions roiled by political and economic instability. Militants in Nigeria continue to attack pipelines; Iran and Venezuela have made vague threats about withholding oil; Iraqi oil output remains vulnerable to ongoing violence there. Though the oil markets have factored in some of that risk, the ongoing threat of a cut-off in supply will keep oil traders nervous, according to Craig Smith, CEO of Swiss America Trading Corporation

“I'm not suggesting we're going to see $78 barrel oil tomorrow,” he said. “But I wouldn't get too overly optimistic until we see some of these very, very critical issues that could affect supply get past us. Until that happens, I think we should have a little bit of guarded optimism here."

What will OPEC do?

Oil inventories have tightened a bit in the past two months, largely due to production cuts from OPEC suppliers in the last few months. That may begin to slow — or even reverse — the recent price slide. And if prices fall further, the cartel could decide to take even more oil off the market to prevent a deeper slide in crude prices.

But OPEC has a history of agreeing to production targets that its members don’t abide by, especially those that rely most heavily on oil to pay the bills. Though OPEC producers need to keep a lid on supplies, prices at current levels are still high enough to spare them serious financial pain, according to Robert Johnson, director of energy and natural resources at the Eurasia Group.

“Most of the OPEC members have their national budgets based on oil prices that are well below where various benchmarks crudes are now,” he said. “So they feel like there is some time before they feel additional pain that could cause them to take action.

Then there’s the wild card of speculation in the oil markets, which became a big source of trading profits in 2006. The summer’s run-up in price was helped by huge inflows of cash from hedge funds and other investors betting that prices would continue to rise. When prices peaked, much of that cash began to flow back out of the market, accelerating the decline.

Now, the latest slide in prices has also been accelerated by investors selling short, betting prices will go lower. But while these investment flows may amplify the market’s moves, the impact is only temporary, according to Kingston.

“In the long run speculative money can not for any length period of time move a market higher or lower than it would be that it would be otherwise,” he said. “In a short period no doubt about it over time, supply and demand fundamentals have to rule.”

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