The Implications of Crude Oil’s Latest Plunge

Another ill wind blowing through the oil industry could give most consumers--and most other businesses--a little holiday cheer in a lackluster economy.

Crude oil prices plummeted more than $1 a barrel Monday in the first worldwide market reaction to several factors--not the least of which was last week’s meeting of the Organization of Petroleum Exporting Countries.

The U.S. benchmark crude, West Texas Intermediate, fell $1.07 to $15.31 a barrel for January deliveries--within a penny of a five-year low on the New York Mercantile Exchange.

Most oil company stocks fell sharply as well but recovered by the end of the trading day. Generally, stocks of companies that benefit from low fuel prices gained, with transportation being the big winner.

The result? Economists generally agreed that consumers could have slightly more money in their pockets as early as the December holidays, though Social Security recipients and others with incomes tied to the federal consumer price index may feel a pinch next year if inflation stays in check.

Some questions and answers on the ramifications of the oil market turmoil:

Q: What has been causing oil prices to fall, and what prompted Monday’s big drop?

A: In the weak worldwide economy, there is simply much more oil than industry and consumers need. Oil demand has been virtually flat for the last two years, while some OPEC nations and other producers--particularly in the North Sea--have increased production, flooding the world market with even more oil.

This cyclical low, as economists call it, was compounded last week when OPEC’s oil ministers decided to continue the cartel’s current production levels, placing their hopes for firmer prices on expectations of increased demand for winter fuel.

On Friday, traders were made even more bearish when Iraq announced that it was willing to make peace with the United Nations in the wake of the Gulf War, in exchange for the right to pour even more crude oil into the world market.

*

Q: How low could oil prices go if trends don’t reverse?

A: No one knows. But few oil watchers expect prices to rise anytime soon.

Vahan Zanoyan, senior director of the Washington-based Petroleum Intelligence Group, predicted that West Texas crude will fall below $15 a barrel sometime in the next few weeks.

“We don’t see a free fall here,” Zanoyan said Monday. But if individual OPEC countries increase production to gain market share, he added, “it could be more dangerous.”

Indeed, Ann-Louise Hittle, director for world oil at Cambridge Energy Research Associates, predicted that OPEC’s plan for firmer prices could succeed if cartel members hold to their current production quotas “and if there’s normal winter weather.”

*

Q: What does this mean to the economy as a whole?

A: Low oil prices generally bring lower inflation and lower interest rates.

Robert D. Barr, deputy chief economist at the U.S. Chamber of Commerce, said interest rates--including home mortgage rates--which have taken a turn upward in recent weeks could come down “a bit” as a direct result of the crude price drop.

Barr and others expect some benefit as well to U.S. auto makers and to energy-intensive manufacturing industries such as steel and transportation companies. The Dow Jones average of transportation stocks was up almost 1% on Monday on strong buying fervor.

*

Q: What do these events mean for oil companies?

A: Oil firms can be roughly divided into three types. Those that get most of their revenue from hunting and extracting oil are by far the hardest hit when the price for their product goes down. For example, Occidental Petroleum Corp.’s stock has fallen more than 5% in the past month.

On the other end, those that buy others’ crude to refine into fuels, chemical feedstock, asphalt and other retail products see wider profit margins when they have to pay less for their basic ingredient. The stocks of such refining companies as Tosco, Sun and Ashland Oil have held steady.

More complex are the effects of low prices on big, integrated oil companies that hunt for oil, refine it and more. Integrated companies--including Chevron, Texaco, Amoco, Exxon, Arco and others--have lost 5% to 20% of their value in recent weeks.

Overall, the price of crude oil “is in principle the single greatest driver of oil company stock prices,” said Thomas G. Burns, Chevron’s manager of economics.

*

Q: How could consumers feel the effects?

A: Lower transportation costs ultimately mean lower prices, not just for airline tickets but for groceries as well.

“It also makes sense that if your gasoline bills are lower, you feel you have a little more money in your pocket and maybe you’ll spend it on clothes,” said Marina T. Carlson, a portfolio manager for Strong/Corneliuson Capital Management Inc., a Milwaukee-based mutual fund group.

U.S. gasoline prices have fallen 3 cents a gallon since October, according to retail petroleum analyst Trilby Lundberg. Prices could go lower still by the end of December--”though certainly it would have to be more than one day of falling on the futures market,” Lundberg said.

*

Q: With the market so weak, what could happen next?

A: Several analysts speculated that if the slide continues, OPEC could be forced to convene its first emergency meeting since 1986 in an effort to firm up prices.

Ahmad Al-Baghli, Kuwait’s oil minister, agreed Monday that if prices don’t stabilize, OPEC will probably meet before its next scheduled conference in March.

On the Skids

Spot prices for crude oil have plummeted to their lowest levels in three years, with OPEC unable to keep a tight lid on production and Iraq reaching an agreement with the United Nations that may free it to resume exports for the first time since the Gulf War.

Oil price per barrel, current contract:

Monday: $15.31

Source: Bloomberg Business News