Well, so much for a future of $200 oil

/ Source: Forbes

Oil prices fell below $120 a barrel this week, touching levels last seen in May, as investors began to rethink the idea that crude is on an inevitable march to $200.

Light sweet crude oil fell as low as $119.50 on the New York Mercantile Exchange on MOnday amid increasing evidence of falling U.S. demand and ample worldwide supplies. That helped drag down the shares of energy firms like Exxon, which fell 3 percent to near its 52-week low of $77.26 and oil-services giant Schlumberger, down almost 5 percent to $95.

The pullback is vindication for analysts who for months have been saying that oil prices had entered bubble territory on a mix of financial speculation, worries about a military attack on Iran and rapidly increasing Asian demand. With hefty new supplies hitting the global market from Saudi Arabia, Libya and even Iraq, those analysts say, oil is likely to fall below $100 soon.

"This fall is a reaction to overshooting over the past couple of months," said Daniel Ahn of Lehman Brothers, which has issued several reports suggesting oil prices were unjustifiably high. "The fundamentals of new supplies suggest prices will be in double digits."

Saudi Arabia apparently hit its target of 9.7 million barrels a day in July, silencing skeptics who suggested the kingdom was running out of crude. The Saudis were pumping 8.5 million barrels a day this time last year, said oil-markets analyst George Littell with Groppe, Long & Littell in Houston, as they anticipated increases in non-OPEC production that failed to come through.

Now, Littell says, "they're running flat out."

All that new Saudi oil is hitting the market amid a steady recovery in oil production from the Gulf of Mexico, where Hurricane Katrina demolished rigs and set back plans by months and in some cases years. BP's Thunder Horse platform, which was left a listing hulk by Katrina, finally began production last month and should be pumping 250,000 barrels a day by the end of next year. Thunder Horse is believed to be the largest oil find ever in the Gulf of Mexico.

As oil companies return to their pre-Katrina schedules, Littell says, "we should see one or two of these (new Gulf of Mexico projects) every quarter through 2009."

The turnabout in oil prices has been punishing to investors who jumped into energy stocks just as the market was peaking. The Standard & Poor's Global Energy Sector Index Fund is down 22 percent from its high of $54 in early June, and the Rydex Energy Services fund is down 14 percent.

There could be more declines ahead. Oil prices are still frothy as measured by implied volatility, or the premium the market seems to be placing on options to buy oil at a set price in the future. Implied volatility spiked as high as 52 percent in mid-July as investors speculated that Israel might launch a preemptive strike on Iran's nuclear weapons facilities — possibly before the next U.S. president takes office.

That speculation has dampened a bit, said Ehud Ronn, an energy economist with the University of Texas, with implied volatility currently running around 45 percent. But any number above 30 percent is unusual, Ronn said, meaning investors are still supporting a pretty frothy oil price on little more than speculation something bad will happen to counteract today's ample oil supplies.