Get ready for the oil price drop

After crude oil jumped by $11/bbl in two days, Cato Institute's Alan Reynolds writes that the price hitting $200/bbl in the near future is "quite impossible."

Market analysts often claim oil prices are almost entirely determined by supply. Demand is said to be insensitive ("inelastic") to price. The standard example is that many Americans have to drive to work and most gas-guzzling SUVs will still be on the road even if the affluent few can trade theirs for a Prius. Whatever the price, we'll pay it.

This idea rests on two fallacies. The first is to exaggerate the United States' importance when it comes to ups and downs in worldwide oil demand. In fact, America is using no more oil than we did in 2004.

The second fallacy is to greatly exaggerate the importance of passenger cars in the United States. It's true that Americans are driving less and buying four-cylinder cars - but that's not where we should be looking for serious "demand destruction."

Reynolds goes on to explain that industrial use of oil fuels is already declining in most sectors, one of which we witnessed last week as airlines parked planes, cancelled some routes and reduced employment. But even without a US recession, Reynolds says, oil prices will still fall with industrial declines elsewhere.

In the United States and Britain, industrial production is nearly flat - only 0.2 percent higher than it was a year ago. In many other countries, however, industrial production has dropped over the past 12 months. It's down by 0.7 percent in Japan, 1.1 percent in Austria, 2.5 percent in Italy and Denmark, 2.9 percent in Canada, 5.4 percent in Greece, 5.7 percent in Singapore and 13.3 percent in Spain.

In April, industrial production also fell in India and China. Shrinking industry around the world shrinks demand for energy in general - and for oil in particular.

My college physics professor took great joy in explaining that alarming trends, such as population growth, never continue at the same rate for a very long time. The meteoric rise in the cost of oil is yet another of those trends.

Hat tip: 'The American' magazine

Oil and Energy Posted by JohnGalt at June 8, 2008 12:24 PM