Tumbling Oil Prices May Herald a Bigger Dive to Come

Back when the world economy was booming prior to the credit crisis, speculation about how high the price of oil could go was all the rage on Wall Street. As demand surged, investment bank Goldman Sachs famously predicted $200-a-barrel prices, while more provocative commentators saw the price tag reaching $1,000 a barrel.But today, as the global economy weakly turns the corner after a staggering recession, oil prices are struggling to hang on to the $70-a-barrel range instead. That's at least partly because major demand factors are easing up. China, for example, is scrambling to rein in growth amid concerns about an overheating economy following unparalleled stimulus measures during the crisis. So oil prices are getting hammered and have tumbled about 13% since Feb. 3 alone.

Stability in Iraq Could Lead to an Oil Glut

But consider this: Even those diving prices, though, could start looking high if the massive oil reserves in Iraq are rapidly brought onto the market amid growing political stability in the country, as some analysts anticipate. And given the enormous impact oil prices have on world economy -- influencing everything from overall growth rates to investments in alternative energy, which require high oil prices to make other technologies competitive -- investors would be wise to keep a close eye on their likely direction.

This week's mauling was driven by China's further moves to curb bank lending and thereby dampen its growth, as well as jitters about sovereign debt gripping the world markets, which led to a spiking dollar, Daron Bertillion, director of market analysts at commodity risk management consultancy Mobius tells DailyFinance.

But while citing resistance at the $70 level, Bertillion warns that prices could plummet to the $50 mark given world supply-and-demand levels along with investor risk tolerances. "Overcapacity in China will be an issue at some point," Bertillion says.

"A Disastrous Impact"?

Even as prices fall, vast quantities of oil from new sources may hit the market over the next several years as Iraq's enormous reserves -- long underutilized under Saddam Hussein's regime and U.N. sanctions -- begin to flood the market. Iraqi production could boom from about 1.5 million to 2 million barrels a day now to about 10 million to 12 million over the next decade, potentially overtaking Saudi Arabia as the largest supplier of oil, according to global intelligence firm Stratfor.

"How fast it comes online remains a question, but it could come online extraordinarily rapidly over the next five years," Peter Zeihan, vice president of strategic analysis at Stratfor tells DailyFinance. "That would have a disastrous impact on oil prices in the medium term."

Indeed, a rapid ramp-up of Iraqi oil production could lead to a glut, and impair efforts by other members of the Organization of Petroleum Exporting Countries to keep prices elevated.

Bertillion points to the 140 exploration projects currently seeking more oil around the world, as well as the claim that Iraq could eventually produce 12 million barrels a day, as major potential causes of downward pressure on oil prices.

Left out of the equation for decades, vast Iraqi oil reserves may now be tapped as the violence and turmoil that followed the U.S.-led invasion in 2003 abates and political stability sets in.

"The Tonic That Everyone Could Use Right Now"

The potential of Iraqi oil fields to influence world prices should hardly be a complete surprise, however. Indeed, prior to the invasion of Iraq, some prominent right-wing business executives like News Corp. Chairman Rupert Murdoch had unabashedly pointed to the potential for cheap oil as a major benefit of U.S. military action.

"The greatest thing to come out of this for the world economy ... would be $20 a barrel for oil," Murdoch said in 2003. "Once it [Iraq] is behind us, the whole world will benefit from cheaper oil, which will be a bigger stimulus than anything else."

And despite the environmental impact of increased oil use, and the hit that alternative energy technologies might take if their prices became less competitive, even analysts who aren't ideologically driven point out that a steep price decline would be a big boost for the global economy.

Rock-bottom oil prices are "the tonic that everyone could use right now," Zeihan says. "If oil stayed low for a lasting period of time, many of our economic problems would quickly fade into the past."

Investors who are betting on higher prices and their implications, though, may be in for even more pain.
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