Friday, September 01, 2006

Seeing Corners

After 12 months of bad news on the energy front, we've finally had a pretty good week. Ernesto, which seemed destined to turn into yet another juggernaut threatening our Gulf Coast energy infrastructure, veered off and is instead dousing the eastern seaboard with rain. In Alaska, the latest view of repairs to the Prudhoe Bay oilfield gathering system indicates that production will remain higher, and return to normal sooner than originally expected. The market has taken this on board, and prices for the "front month" NYMEX oil futures contract dipped below $70 for the first time in two months. At the same time, gasoline prices across the US fell by 15 cents in two weeks, with only the West Coast averaging above $3.00/gallon. It's premature to say we've turned a corner, but when you think about what a corner might look like, this could be as close as we get for a while.

I've been watching oil markets for a long time, and I can't remember many occasions when prices dropped like a stone because of some piece of good news. Conversely, we can probably all think of numerous events that caused it to spike up. Major declines tend to be composed of equal parts of big energy news--failed OPEC meetings, the start of the Gulf War--and the gradual accumulation of fundamentals in the form of higher production and inventory and sliding demand. All that may be required for a gradual decline from current heights, however, could be an extended period without a lot of bad news, plus a few positive developments such as those we saw this week. It's worth recalling that as recently as May 24, 2005, the price of oil was under $50/barrel, and a bit more than a year earlier it was under $40.

The cautionary note to all this appears on today's front page: "Iran Defies Deadline on Nuclear Program." Any reprieve in oil and gasoline prices will be temporary, if the forthcoming UN Security Council debate on sanctions for Iran becomes deadlocked and sets us on a path to a wider, unpredictable conflict in the Middle East.

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