Q: Will we see $3 gasoline before $5?

A: It certainly looks that way.

When I first posed this question in August, I began my answer:

peak_oil2.jpgA: “Who knows?” and “It doesn’t really matter.” Much higher gasoline prices that are sustained for a long, long time are now inevitable. The fundamentals in the oil market are that we are in the beginning stages of peak oil. Supply can no longer keep up with demand, which has kept soaring even in the face of record prices.

In August, I had assumed that things had gotten as grim under President Bush as they could get. My bad. I did, however, point out:

In the short-term, I suppose it is possible that we can go back to $3 gasoline, although that would probably require a deep global recession, and prices would only stay low for the extent of the downturn.

But I didn’t think that would actually happen, as evidenced by my 401K. Nonetheless, the fundamentals of supply and demand mean prices are inevitably headed much higher in the medium term. A figure from a new CIBC report makes that clear:


[Note: This is total world production of crude oil (excluding natural gas liquids).]

Even in the face of the staggering rise in oil prices of the last few years, production has barely budged. What about demand? As I noted in August, despite a sharp drop in US oil consumption, “global consumption rose by roughly 500,000 barrels per day (bbl/d) during the first half of 2008.” And that led me to the obvious conclusion that only much, much greater demand destruction can stop the inexorable rise of oil prices. And that obviously requires much higher prices than what we’ve seen in the first half of this year.

That conclusion remains true for the medium-term, but there is another way to get serious demand destruction in the short term — a major global economic slowdown. Given that people have started to use the D-word to describe where our current mess is headed, oil prices can clearly go lower and stay there awhile. If we assume, optimistically, that we avoid a true depression and only end up with a major recession, then the WSJ Environmental Capital blog has a good summary of new price projections:

Analysts and economists at BNP, Goldman Sachs, Toronto Dominion, and Bernstein Research have all said this week crude should be priced between $75 and $80 a barrel. Others, like Canada’s CIBC World Markets, think marginal production costs are the ticket, but that the floor price is a little higher, around $90 a barrel….

And historically, oil prices overshoot the marginal cost of production going up and coming down….

That will make OPEC’s emergency meeting next month in Vienna all the more interesting. If the cartel seriously cuts production to keep prices stable, it risks whacking the global economy while it’s down and destroying demand even faster. But if it keeps oil output more or less intact, history suggests, crude could plummet below $50 a barrel.

[Note to GOP: Drill, baby, drill.]

So even $2.50 gasoline is possible. We are obviously no longer “likely” to see $150-$200 oil by 2010, as Goldman Sachs projected in May, nor are we likely to see $7 gas by 2010, as CIBC projected in June, though CIBC may still be right we are due for “1970s style GDP growth.”

Of course, betting on the market or oil prices in the short run is obviously a fool’s game. But the medium-term analysis remains unchanged. As Jeroen van der Veer, chief executive officer of Royal Dutch/Shell, e-mailed his staff in January, the world will peak in conventional oil and gas within the decade. He wrote: “Shell estimates that after 2015 supplies of easy-to-access oil and gas will no longer keep up with demand” (see “Shell: Conventional oil peaks within 7 years“). And the normally staid International Energy Agency warned in July of an impending oil and gas supply crunch “with OPEC spare capacity declining to minimal levels by 2012.”

Disastrous economic policies cannot prevent peak oil or, rather, its terrible consequences, only very smart government policies can (see “Why electricity is the only alternative fuel that can lead to energy independence“).

Amid all this pessimism, let me end with one optimistic figure from CIBC’s must-read financial market update:


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10 Responses to Q: Will we see $3 gasoline before $5?

  1. paulm says:

    I suspect that Saudi Arabia will have an announcement to make soon on how much oil they have left in reserve!

  2. John McCormick says:

    Joe, I am sure $50 oil will crush the under-construction ethanol plants and the industry in general will suffer huge losses.

    Watching the ethanol rack prices falling nationally tells me I am right.

    Lots of hurt coming to the corn states. I do not wish that upon them but it will happen.

    Joe, can you offer some insight on how lowering oil price is affecting ethanol production?

    John McCormick

    [JR: take a look at the one year stock chart of any ethanol company, like Pacific ethanol (PEIX) or VeraSun Energy (VSE). It ain’t pretty. Much sharper drops than the rest of the economy as a whole. I haven’t looked at the production figures, but of course we have a government mandate which drives that. Existing ethanol is virtually all from corn, which is simply a terrible idea as I and others have said many times. The price collapse in oil obviously hurts all alternative fuels.]

  3. P. G. Dudda says:

    Gas prices also took a dip right before the 2004 election. Call me cynical, but I’m deeply suspcious this is an attempt by BushCo to garner votes. (“See! Prices are down! Vote for us!”)

  4. charlie says:

    Yes, it is a deliberate policy to drive down gas costs for the election. Unfortunately, the Bush people even messed that up and triggered a financial collapse.

    Gas will probably be 2.70 a gallon for the next five years on average. The key factor right now is how much Canadian oil sands really cost and at what point OPEC can drive those oils sands out of business.

    the other questions is US demand structural (i.e. did people get rid of those SUVs and ship them to mexico) or just cyclical (did people drive 15 miles less a month this year, which amounted to 1 million b/d demand loss). If cyclical, it will pick up at 2.70.

  5. Lamont says:

    “We are obviously no longer “likely” to see $150-$200 oil by 2010, as Goldman Sachs projected in May”

    CALLED IT!!!!!!!!!!

    check out the comments section of that article where I mentioned that demand destruction due to worldwide recession would cause gas prices to drop, and that Goldman Sachs coming out with a $200/bbl oil call almost certainly was a contrarian indicator.

    people followed up saying i was “nonsensical”.

    yeah right.

    I CALLED IT!!!!


    (I watch way too much colbert)

  6. David B. Benson says:

    “Promising New Material Could Improve Gas Mileage”

    by maybe 5–10%

  7. Lamont says:

    I think the $60/bbl price I briefly mentioned may have been way too optimistically (?) high as well. I didn’t realize how bad the current market conditions were going to get.

    Peak oil is still lurking in the background, though. Any global recovery will meet the headwinds of expensive energy again unless there’s a major push towards renewables and green energy.

    I’m still trying to figure out if the US dollar will devalue or not. Right now there is a very obvious panic to US currency, however, and a shortage of it (seems unbelievable given the $850bn bailout — but we’ve lost >$5T in US market cap and $3.7T in housing value so we are definitely in a deflationary spiral). We are more likely to see currency crises in foreign currencies (latin america is already trying to defend their currencies and there’s major selloffs in asia, and iceland was too small and has already gone under). I was wrong about gold and it has been holding its own in $USD, while in other currencies it is exploding as their currencies devalue.

    After that I honestly don’t know what is left standing. I don’t know if this is just a bad recession in the US, or 30% unemployment great depression. If output is destroyed enough so that productivity and GDP fall so low that it sparks hyperinflation there could be a flight out of the US currency, but its way too early to see those signs. But there’s going to be a huge debt, higher interest rates and the spectre of peak oil and reinvigorated inflation waiting for any recovery that Obama engineers. Bush really screwed this country up… thanks for the extra $5T in debt right when we need to deficit spend, asshole…

  8. David B. Benson says:

    “The price dropped $5.61 to $77.05 a barrel on London’s ICE Futures exchange on Friday.

    While on the New York Mercantile Exchange, crude oil for November delivery fell as much as $3.08, or 3.6 per cent, to $83.51 a barrel, the lowest since October 2007.”

  9. David B. Benson says:

    “Using Plants Instead of Petroleum to Make Jet Fuel”

  10. David B. Benson says:

    $3.279 a gallon here today. That’s exact;y one dolar off the high.