Is the Price of Oil Too Low? - December 18, 2008

Is the current price for gas good or bad for the economy? Following OPEC’s announcement yesterday to cut crude production has not really had an affect on the lack of demand for oil.

Late yesterday, the 12 members of the Organization of the Petroleum Exporting Countries (OPEC) confirmed that they were cutting output by 4.2M barrels per day from its September production level, effective January 1. The cut now leaves the members to produce 24.845M barrels per day.

With oil reaching record highs over $147 a barrel in mid-July, consumers have conditioned themselves to drive less, or carpool, and not take long road trips for the holidays or vacation.

Correspondingly, the price of retail gasoline was on an 86-day decline until the beginning of the week. During such time, the price dropped from its high of $4.114 a gallon to today’s national average of $1.656 per gallon. Over the past month, retail gas has dropped over $2 a gallon and nearly $3 a gallon over the past year.

The International Energy Agency went on to acknowledge that, despite the cut in production, the markets will not respond immediately due to the strong decline in demand as the economic and financial crisis continues to deepen.

To take steps even further, the U.S. planning commission, the Cabinet’s National Development and Reform Commission stated today as well that the price of diesel with be cut by 18%, while the price of gasoline will drop nearly 14% effective tomorrow. On top of that, jet fuel prices will be cut by 32%.

By the close of the oil markets today, it was evident that the cut in production had mixed results. The January contract for crude, which ends tomorrow, dropped more than 9% in today’s session, giving up $3.75 to settle at $36.31 a barrel. Oil has not seen these prices since July of 2004.

However, the February contract, which showed greater volume in trading today, slipped by 7% or $2.93 to settle at $41.64 a barrel.

In response to OPEC’s cut, JPMorgan (JPM) cut their 2009 average crude oil price from $69 a barrel to $43. Other market analysts, including those at JPM, expect additional price cuts until unless a significant amount of surplus in oil is taken off the markets.

Economists, and analysts alike, believe that if the price for a barrel of crude slides near the $30 level, that OPEC will reconvene to discuss further daily production cuts.

With a deepening recession reaching worldwide, the falling price of crude is great for consumer in general, but terrible for the producing countries as a whole. "You must understand the purpose of the $75 price is for a much more noble cause," the Saudi Oil Minister said. "You need every producer to produce and marginal producers cannot produce at $40 a barrel."

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