Latest News

Oil Q&A: Supply, demand and speculation could drive prices even higher

WASHINGTON — Oil prices rose to another record Monday, settling above $127 for the first time as gasoline prices continued to move toward $4 a gallon.

Light, sweet crude for June delivery jumped 76 cents to settle at a record $127.05 a barrel on the New York Mercantile Exchange. At this level, gasoline prices — already averaging $3.79 a gallon — could hit $4 a gallon next month, Geoff Sundstrom, fuel price analyst at AAA, told The Associated Press.

Are these once unthinkable prices a high-water point, or just another pause on an upward march?No one knows for sure. Experts argue forcefully for a fallback or a continued rise. Here are some answers to questions about what comes next for rising oil and gasoline prices.

Some analysts predict $200 a barrel. Is this possible?

Goldman Sachs & Co. recently grabbed headlines with a research note that examined that possibility. In March 2005, Goldman suggested that oil could pass $100 a barrel, and its call now seems prophetic. On March 16, Goldman forecast an average oil price of $141 a barrel for the second half of 2008 and a spike to $200 a barrel if supplies are disrupted.

If world economic growth remains solid and the U.S. economy begins rebounding in the second half of 2008, it’s likely that oil prices, and thus gasoline prices, would go even higher.

“If we got back on a fast global growth track, that would put additional pressure into an oil market where new capacity is being delayed, postponed, not developed,” said Daniel Yergin, an oil historian who runs Cambridge Energy Research Associates.

Yergin recently published a research report that outlined how prices could climb somewhere in the range of $150 to $200. “We could imagine today that you could see oil rise if the dollar continued to weaken, in the very near term oil could spike higher,” he said.

If oil prices rise high enough, wouldn’t that lead to less consumption, more supply and lower prices?

That’s the definition of demand destruction, where prices rise to an unsustainable level and fall back. It seemed we were there at $90 a barrel, $100 a barrel and so on. The U.S. Energy Information Administration and the Paris-based International Energy Agency both have revised downward their forecasts for oil demand this year in the United States and globally.

“The important point is it is still demand growth,” said John Felmy, chief economist for the American Petroleum Institute, the lobby for Big Oil.

Are the fundamentals of supply and demand in play, or are these high prices the result of speculation?

Clearly, there are underlying problems of supply. Production is flat in Russia, the world’s second-ranked oil giant after Saudi Arabia. Civil unrest in Nigeria is knocking out about 1 million barrels per day. Iraq has never returned to prewar production levels. Increasingly belligerent Venezuela has seen production fall year after year, and Mexico seems unable to reverse a production decline.

On the demand side, the global economy seems to have shrugged off the U.S. downturn, and China and the Middle East are each gobbling up about a third of new oil production for their fast-growing economies. Both China and oil-rich Middle Eastern economies subsidize gasoline prices and to some extent electricity rates. This removes price signals for consumers that otherwise would bring about more conservation.

The recent earthquake in China is likely to increase the need for oil, both for reconstruction and for power needs. Japan is consuming at least 200,000 barrels a day more than it otherwise would have after a decision to close some nuclear reactors.

With these variables at play, it’s easy to see why investors who are nervous about the stock market or a falling U.S. dollar would see a safer bet on oil prices going even higher.

So it’s not speculation?

That question is now being hotly debated. The Commodities Futures Trading Commission, which regulates the trading of contracts for future delivery of oil — called futures — believes that big pension funds and other institutional investors may accentuate a trend but are not the cause of high prices.

“If the fundamentals weren’t strong, you couldn’t play on the margin [speculate] in any event,” said Frank Verrastro, director of energy programs for the policy-research group Center for Strategic and International Studies.

Others, including Sen. Carl Levin, D-Mich., believe that the “Enron Loophole” is to blame. This removed from regulation the electronic trading of oil futures by large traders. Some experts believe that oil traders are pushing trades into less-regulated overseas markets where they can escape direct scrutiny by U.S. regulators.

These big positions can move markets. Exhibit 1 is the spectacular 2006 crash of Amaranth Advisers, a hedge fund that pooled investments from ultra-wealthy investors to take huge positions in futures contracts for natural gas. In doing so, it drove up the price for Americans of heating and cooling their homes. Last summer, federal regulators, well after the fact, accused Amaranth of manipulating prices and fined it almost $300 million.

What’s being done about this loophole?

A farm bill passed by the Senate last week by a veto-proof margin includes a provision to close this loophole and bring greater record-keeping and scrutiny to electronic trading of oil futures.

Democratic presidential candidates Barack Obama and Hillary Clinton want the loophole closed. A top adviser to GOP candidate John McCain said the candidate has no position on the issue.

The Enron Loophole came to be thanks to the efforts in 2000 by Texas GOP Sen. Phil Gramm, who today is McCain’s closest economic adviser and is a close personal friend. Gramm’s wife, Wendy, was once the top commodities regulator in the United States and later was a member of Enron’s board of directors.