Why gas prices will go back up

From the Lowell's Corporate Office of Fearless Predictions:

Gasoline will be well above $3 a gallon by June, if not sooner.

The recent and dramatic decline in gas and oil prices has been great news for our wallets and our troubled economy, and the extra cash has provided some much needed relief from the barrage of recent bad news.  Oil is trading under $39 a barrel as I write this (It had topped $140 a barrel this summer).

But it won't last. 

How can I so sure?  I think part of the answer lies in how oil prices collapsed.  So we'll start there.

The Collapse

Three events converged — and then fed one another — to drive oil and gasoline to multi-year lows.  

Supply / Demand.  First, the economic slowdown combined with gas pump sticker shock to cause people to really pull back from using as much oil — fewer and shorter trips.  Meanwhile, petro-regimes were ramping up production, greedily grabbing for historically high petroleum prices.  More oil + Less consumption = Lower prices.

Stronger Dollar.  This summer, really low interest rates had made the dollar incredibly weak in the world market.  Essentially, each dollar bought less of everything from other countries (including oil).  As the US slowdown began to hit other countries in early autumn, and their banks lowered interest rates too, the dollar was suddenly much stronger.  As a result, each dollar now bought much more oil.

Financial Meltdown.  Finally, much of the run-up in oil prices was driven by speculators in oil-based securities in the financial markets.  The speculators drank their own outrageous Kool-Aid as firms like Goldman Sachs predicted $250-a-barrel oil by the end of the year.  As so many financial firms imploded (think Bear Stearns, Lehman Brothers, Washington Mutual, Merrill Lynch, etc.), they unloaded their more-profitable oil holdings in a panic to generate additional cash. 

Any one of these trends would have driven down prices somewhat, but combined, they caused prices to fall to almost one-fourth of their summer highs.

The Coming Spike

There are signs that a couple of these trends are reversing, and that there will be a near-term spike in the price of oil.

Weaker Dollar.  The recent moves by the Federal Reserve to take their funds rate to 0% have not been followed by similar moves by bankers in Europe and Asia.  This has served to significantly weaken the dollar in the global markets.  Each dollar will buy less oil and gas.

Less Oil.  OPEC members, watching their rivers of cash dwindle, have recently indicated that they will curtail production in order to restore higher prices.

Greater Demand.  At the same time, the US and other countries are stoking the economic engines with incredible amounts of 'rocket fuel': The government's huge economic stimulus packages and dramatic financial moves — from 0% interest rates to "infrastructure" projects to direct cash injections into failing firms — will (eventually) ignite, and will help the economy rebound, probably very aggressively.  As the economy takes off, much more oil will be needed to move products and rebuild infrastructure.

Speculation.  I would expect some moderation in the financial speculation — many
speculators just aren't around anymore — so I'd be surprised if the
prices reach the levels of this past summer.  There's also the Kool-Aid factor: Merrill-Lynch recently speculated
that oil prices would drop all the way to $25 a barrel.  They'll likely
be as outrageously wrong as Goldman's $250 prediction…

I'd look for these counter-trends to get traction in early January, and for the economic rebound to begin gaining steam in the April – May timeframe.  By June, these counter-trends will work together to drive oil and gas prices up again.  Netting it all out: I would expect gas prices over $3 per gallon and oil prices over $80 per barrel.

But that's just my crystal ball…  What do you think?  Where will prices be in 6 months?

[where: 111 Mechanic St, Lexington, KY 40507]

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