Economy, Geopolitics Guide Oil Price

Why are oil prices rising when the situation in Iraq seems to be improving, tensions with Iran appear to be easing and a mild late winter is expected in the US?

Now that the price of crude oil has crossed the psychologically important US$100-a-barrel threshold, and then retreated, what direction will it take next?

Many experts say it will go up, then down, and then maybe up again. That, anyway, has been the pattern of the last several years of volatile prices.

The arguments for even higher oil prices are well known. The economies of China and India are booming and hungry for energy. Oil fields in Mexico and the US are drying up, tightening world supplies. Venezuelan President Hugo Chavez is using oil as a political weapon. Rebels in Nigeria are creating havoc in some of Africa's most productive oil fields.

The war in Iraq rages on. The dollar is weakening, causing hedge funds and traders to flee to oil and other commodities as a safe haven.

But all those factors were in play last summer when the price fell to about US$60 a barrel, before it rallied at the end of the year. The price touched US$100 on Wednesday and surpassed that briefly on Thursday before retreating after the US government reported higher-than-expected heating oil and gasoline supplies. The price settled at US$99.18 a barrel, down 44 cents.

"Predicting oil prices continually demonstrates the perils of prophecy, because oil prices are the derivative of what happens in the global economy and global geopolitics," said Daniel Yergin, chairman of Cambridge Energy Research Associates. Yergin said he could foresee oil prices surging as high as US$150 in the next few years or falling as low as US$40.

John Richels, president of the Devon Energy Corp, an international oil and gas company based in Oklahoma City, said US$150 a barrel was possible, but so was US$55.

"We have to make investments based on our outlook over a long period of time," he said. "It is tough."

Central to the question of where oil prices will go is the effect of high prices on the consumption and development of alternative fuels.

Large amounts of public and private investment are going into solar, wind and biofuel development, but so far they are making only a slight contribution to energy supplies. Scientific and engineering leaps, like developing the atomic bomb or sending a man to the moon, can be made relatively quickly, but they are still measured in years.

Until now, most economists have been surprised that the steady rise in oil prices -- from as low as US$11 less than a decade ago -- has not had a greater effect on US consumers. But with oil prices rising at an increasingly rapid rate over the last few months in conjunction with the housing market slump and credit squeeze, many economists wonder whether oil prices could tip the economy into a recession.

A recession, of course, would curb oil demand. That would push oil prices right back down again, or so the theory goes, as fewer consumers drive to the mall, companies produce and ship less and world trade slows.

"If we are slowing down, we will not be buying as much goods from China and services from India," said Addison Armstrong, director for market research at Tradition Energy, an energy broker that deals with banks and hedge funds.

"My forecast for 2008 is that crude prices will average US$75 a barrel, and that is based on a scenario of a slowing economy in the United States," he said.

But Armstrong and other experts cautioned that a protracted insurgency in Nigeria, a punishing hurricane season or other unpredictable events could take oil prices up.

So why are oil prices going up now? The military situation in Iraq is arguably improving, and Iraqi oil exports are beginning to flow again. Tensions with Iran have eased a bit. There are forecasts for a mild late winter in the US, which should help bolster oil and gasoline inventories going into the spring and summer driving season.

Many experts say the answer lies in the investment decisions of traders and hedge funds. With the markets in equities, housing, credit and currency shaky in the US, traders are betting on oil and other commodities as a perceived safe haven.

Phil Flynn, a vice president and market analyst with the Alaron Trading Corp in Chicago, said the recent interest rate cuts by the Federal Reserve had underscored for traders the depths of the country's economic risks and led them to buy oil futures.

Flynn said he thought that oil prices were more likely to fall than rise, "because I think the factors that drove us to today are unlikely to repeat in 2008."

He added that he thinks the dollar will find a bottom this year and that the problems in housing are already priced into the markets.

But most experts say that if oil prices do go down, they will probably not go down very far or for very long.

Richels of Devon Energy said that consumers in Europe and Japan were not feeling the same pressure as Americans because their currencies have been strengthening and not weakening.

"There is still a lot of demand that is outside of the United States," Richels said. "There is increasing oil consumption, particularly in the developing nations, and oil is getting more difficult to find."

NY TIMES NEWS SERVICE, NEW YORK