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Web Extra Friday, April 8, 2005

Oil prices outlook high

Last week, a Goldman Sachs analyst put out the word that the price of a barrel of oil could "spike" to $105 in the next few years. The report sent prices for crude shooting past $56 a barrel.

But the likelihood of hitting such an extreme oil price — at $105 per barrel, almost twice the current value — is not so high, according to other analysts. New calculations show that imbalances in the market could cause light crude oil prices to increase to levels above the $55 per barrel average, which the Energy Information Administration (EIA) says in its short-term outlook, published yesterday, according to Margot Anderson, director of EIA's Office of Energy Markets and End Use.

EIA also released its forecast for prices at the pump yesterday, looking ahead to the next 18 months, and consumer prices certainly are high. This summer, a gallon of gas will most likely cost an average of $2.28 per gallon at the pump, from April to September, which is 38 cents higher than average prices last summer. The agency predicts such high gasoline prices will last until next year. The projected peak is $2.35 per gallon in May. A Goldman Sachs-type spike "is not in our lexicon," Anderson says.

Based on their report, Goldman Sachs seems to have been exploring scenarios for what could happen, should a major oil supplier shut down, or in the event of an oil crisis like the one in 1980 and 1981, even though they say prices are rising in the absence of such an event.

Globally, the high cost of a barrel of oil has propelled the European Central Bank to vote to raise its interest rates in order to stifle impending inflation. In the United States, similar concerns linger over how gasoline prices will radiate out to affect other the costs of other goods.

It's all about consumer expectations, says John Felmy, chief economist for the American Petroleum Institute. In the context of prices in 1981, a barrel of oil cost $80 to $90 in 2005 dollars. Drivers did change their behaviors then, switching to more fuel-efficient cars, and, Felmy says, "there's some indication that consumers are cutting back" now, as sales of large SUVs drop. Still, the shift has been to smaller SUVs, he says, with no change in vehicle miles traveled, and "gasoline is still only a small share of operating a motor vehicle," at 20 percent.

In general, the greater point Goldman Sachs may be making is that consumers only change their gas-buying habits if they think that the high prices are permanent, Felmy says. And, "if they think it's short run, they're not going to react very much," which seems to be the case at the moment.

The volatility remains in the larger market for oil barrels. "The market is so tight and volatile, any little thing could send it up or down," Felmy says, and the Goldman Sachs report last week turned out to be just one of those little things.

Felmy also says that "whether it's corn or oil, the cost of production is only part" of the world price of oil. Even though a barrel goes for $50 or more, it still costs only $1 to produce it in Saudi Arabia, he says.

Last week's market response "seems to be little more than a reflection of the truth that there is no necessary cap to oil prices, depending on circumstances," Barclays Capital analysts wrote in their weekly report. "Put together the right set of parameters, no matter how unlikely they might be, and you can generate any higher price you care to mention."

Naomi Lubick

Links:
EIA Short-Term Energy Outlook, April 7, 2005
"At the pump," Part I and Part II, Geotimes, May and June, 2004

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