Tuesday, October 16, 2007

$100 or Bust?

While I was traveling yesterday, oil prices set another record. From $86/barrel, the idea of breaking $100 before the end of the year doesn't seem nearly as implausible as did a few months ago. Happily, I'm not in the business of predicting oil prices--we're already beyond where I'd have expected prices to top out. However, I am in the business of considering the implications of future scenarios, and at this point I think it's more interesting to consider what $100 oil might mean, rather than guessing when and whether we'll see it.

First, $100/bbl would finally vault us past the previous inflation-adjusted peak price from the early 1980s, at least for the light, sweet crude priced by the NYMEX WTI and ICE Brent contracts. Even though the US economy is much less sensitive to oil price increases than it was in the 1970s-80s, since it has become much more efficient, there must be some point at which higher oil prices--even if they're partly driven by a weaker US dollar--start to slow the economy, either by stimulating producer-price inflation or because they are the equivalent of a tax on consumption. $100 might not constitute a magic level at which those effects would suddenly kick in, but it would represent a doubling of nominal prices in three years and a quadrupling in five years. That's approaching "oil shock" territory, even though the process has been a lot more gradual than the shocks of the '70s.

What it would mean for gasoline prices depends on refining margins, which have weakened significantly from their stratospheric heights earlier this year. If refining margins in the fourth quarter of 2007 remain comparable to those in 4Q06, then we could expect a US average pump price of around $3.20/gallon for unleaded regular, versus $2.77 today. (If margins spiked again, it might go as high as $3.60/gal.) That ought to be enough to elevate fuel economy in car-buyers' priorities and put a big dent in the recent resurgence in the sales of large SUVs, while giving hybrids and crossovers a bigger boost. However, I doubt it would be enough to change fuel consumption dramatically, because so many elements of our driving patterns are tied to our lifestyle choices.

Lurking behind these implications is the larger question of the psychological impact of reaching the $100 mark. We've come so far in the last few years, I'm not sure another $15/bbl would make much difference. Consumers complain about high gas prices, and demand is growing more slowly than it was previously, but the sea change that promoters of alternative energy and higher efficiency have been hoping for remains elusive. Has the gradual climb from $25 to $40, $50, $65, $70, and then recent sprint past $80/bbl numbed us and obliterated our memory of just how unthinkable all this seemed not very long ago? Could $100 shatter our complacency, or would it be just another turn of the dial on the boiling frog? I can see it going either way, with very different results in each case: two complex scenarios, instead of the simple one we started with. One sets up radical energy change, while the other preserves the current evolution, gradually adding new sources to our traditional ones. The latter sounds much less glamorous, but it would also be a lot less disruptive and a lot more predictable.

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