Are sky-high oil prices ahead?

One thing about the oil market: it's bound to hold your attention, whether you're an investor looking for growth plays or just a typical car owner.

Certainly if you're an American driver, oil is holding your attention. Just take a look at that gas pump price: a national-average, regular unleaded gasoline price that's risen about 60 percent (!) in six short months, to about $2.63 per gallon, according to data compiled by Moreover, the price rise is all-the-more exasperating because it's occurred while the U.S. economy is in recession, with millions of drivers taken off the road, due to belt-tightening and job-layoffs.

Most of the roughly $1 per gallon rise in gasoline prices stems from the $35 per barrel increase in oil's price since December 2008, to about $71 per barrel on Friday.
Why has the price of oil basically doubled despite the fact that the U.S. and global economies are still in recessions? Among other factors, institutional investors, citing 'green shoots,' are calculating that each recession has bottomed - the recoveries may have already started - and that implies increasing oil demand in the quarters ahead, hence they're positioning themselves in what they believe will be a high-return asset: oil.

Are sky-high oil prices ahead...again?

What? Another period of sky-high oil prices? (As if $70 wasn't high enough!) The aforementioned is likely to be greeted by Americans with the same enthusiasm as a resurgence of the H1N1 flu. American consumers and business executives know what a high oil price does to the U.S. economy: it severely reduces consumers' disposable income and increases business costs at virtually every stage of the production process. It also increases inflation. And sky-high oil price eras - the world's three oil shocks - have been major factors in the U.S. recessions of 1973-74, 1979-80, and 2008-9. Further, the U.S. is still recovering from the effects of $147.27 per barrel oil surge of 2008: a second run at $100-oil would be like a left hook from former heavyweight boxing champ 'Smokin' Joe Frasier: a devastating blow. Are we destined to experienced another, prolonged period of $100 oil, or even worse? Here are two competing arguments.

Veteran oil analyst Matt Simmons says we are. Simmons, founder of Simmons & Co., argues oil's price plunge from record-highs last year to below $50 took many oil fields out of production. The low oil price forced many oil companies to delay projects, decrease the number of rigs deployed, consolidate operations/lay-off staff, and above all, to abandon expensive projects. That deceased production, plus aging oil fields and the credit crunch's impact on oil exploration, help set the stage for the current price rise. What's more the price rise will continue, Simmons argues, because producers will not be able to increase global oil supply fast enough to keep up with soon-to-be rising global oil demand. Simmons believes the average daily price of oil in 2010 will be $200 per barrel (in 2005 dollars).

Bloomberg Columnist William Pesek says visions of $200 or $250 per barrel oil represent a stretch, at best. Much of that rise in oil's price, Pesek says, hinges on China's ability to drive global growth. However, a considerable portion of that China-based demand is for raw materials, and will not lead to large, spin-off growth effects for economies in Asia, or globally. In other words, China's economy is not going to create demand for parts and other goods assembled outside China, and once investors realize China's still-export-oriented economy can not grow more than 6 percent per year, the commodity bubble or "bubble of belief" will burst, and so will oil's price. The key point in Pesek's thesis is a frugal consumer era, led by reduced consumption in the United States – a major market for China's exports. Once it's clear exports will not return to pre-recession days, China's lopsided economy will be exposed, and down goes the price of oil and commodities. Those calculating that a China boom will lead to $250 oil are in for a disappointment, Pesek said.

Oil Analysis: Columnist Pesek offers evidence that dispels notions that China's economy, currently structured, will be the global growth engine that many expect it to be, but it's awful hard to take a position against Matt Simmons, one the oil industry's best analysts. Further, oil's vault to $70 in a macroeconomic eye-blink, amid the recession, is alarming, so the bias here tilts toward Simmons' analysis. From a U.S. standpoint, that only underscores the need for a national energy policy, and President Obama's policy to increase vehicle fuel efficiency and conservation by businesses and homes represents a good first step.
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