WHY OIL PRICES WILL TANK
June 12, 2008
Arguments that $4-a-gallon gas (or even higher) is here to stay are dead wrong. High-flying tech stocks crashed. The roaring housing market crumbled. And oil, rest assured, will follow the same path down, says Shawn Tully, editor-at-large of Fortune magazine.
Basic economics make it clear that the only question is when -- not if -- prices will succumb, says Tully. The same forces contributing to the jump in oil prices are causing a classically unstable market that's destined for a steep fall.
- A big swath of the market isn't really paying that $125 a barrel number often quoted in the media; in China, India and the Middle East, governments are heavily subsidizing oil for their consumers and corporations, leading to rampant over-consumption -- and driving up prices even more.
- When the price is $125, the incentive to pour out more oil, like homebuilders' incentive to build more two years ago, is irresistible.
- Eventually, the price must fall back to the cost of that last barrel to clear the market, which costs just $50 to produce, says Stephen Brown, an economist at the Dallas Federal Reserve.
- The longer prices stay stratospheric, the worse the eventual crash -- simply because the higher the prices and bigger the profit margins, the bigger the incentive to over-produce.
That's just the supply side of the equation. Demand should start to decline as well, explains Tully.
- Historically, the oil market has under-anticipated the amount of conservation brought on by high prices.
- Sales of big cars are collapsing; Americans are cutting down on driving; and the airlines are scaling back flights.
- In the 1970s and early 1980s, the price spike caused the world to cut back sharply on oil consumption; by the mid-80s, oil prices had fallen from almost $40 to around $15 and remained extremely low for two decades.
Source: Shawn Tully, "Why Oil Prices Will Tank," Fortune, June 9, 2008.
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