Watch Out Below!
Falling oil prices may burn investors, but drivers can rejoice
Oil economist Philip Verleger, who works out of Aspen, Colo., watched the dizzying slide of the petroleum market over the past month and thought of the pioneers who mistakenly imagined the Great Plains would rise steadily to the heights of the majestic Rockies. "In some cases, though, deep-sometimes impenetrable-valleys lay between the travelers and the mountains," he reminded his clients last week.
Could this be the edge of a cliff for all those investors who poured money into the oil market (Verleger's estimate is $100 billion) over the past two years? Crude oil prices, which had become comfortably ensconced in the $70s for much of the summer, fell for seven straight days, dipping below $64 per barrel for the first time since March before recovering slightly. The average price of $2.62 a gallon that Americans paid at the pump last week was the lowest since early April and 14 percent below its August peak.
Fuel prices typically fall at the end of the summer, especially when the hurricane season has been quiet. But many analysts believe that the seasonal slowing of demand and easing of pollution rules for refiners only partially explain a drop-off of this speed and size. They believe that the fall has much to do with the complex impact that speculators-not just risky hedge funds, but plain old mutual funds, pension funds, and other institutional investors-are having on the oil market. And if the geopolitical situation is status quo and signs of global economic slowdown continue, they think a hard fall in oil prices could be ahead. Last week's decision by the Organization of Petroleum Exporting Countries to maintain current production is a key factor; analysts believe OPEC is divided on cutting back the flow of oil.
"I'd say there's a 10 or 15 percent chance that people could see $1.75 gasoline by Thanksgiving," says Verleger.
Market rally. The stock market was certainly bolstered at the prospect of the first weakening in oil prices in months. The Dow Jones industrial average gained more than 100 points last Tuesday, hoping that a fall in crude would lift consumer spending and corporate profits and ease the risk of inflation. It certainly will factor in Federal Reserve Chairman Ben Bernanke's calculations when the Fed's monetary policy committee meets this week to decide whether to raise interest rates. Economist Robert Mellman of JPMorgan Chase says falling oil could boost economic growth to an annual rate of 3.7 percent in the fourth quarter, up from his previous projection of 3 percent.
The scenario is not so rosy for latter-day oil investors. Any doubt that the new breed of commodity speculators was moving the market was erased last month, when the Goldman Sachs Commodity Index dramatically reduced its exposure to gasoline-a massive liquidation of tens of thousands of futures contracts that caused the price to fall 18 cents, more than 8 percent, in one trading session. Gasoline prices haven't shown much buoyancy since, and many believe they're pulling down crude prices with them. Goldman Sachs, which produced a notorious research note last year predicting $105-per-barrel oil, had heavily promoted its index as a way for nontraditional investors to diversify. But that strategy doesn't look so great this month.
"Unfortunately, a lot of people have deceived themselves and said, 'I'm not investing in oil; I'm investing in a broad basket of commodities,'" says Bill O'Grady, analyst at A.G. Edwards & Sons. "But you basically own oil."
The darkening picture for investors, however, has a bright side for many more Americans-those watching prices ease daily as they buy their oil the old-fashioned way, to fill up their gas tanks.
This story appears in the September 25, 2006 print edition of U.S. News & World Report.
advertisement
