Oil prices may go down in 2008

Many energy experts are predicting that the price of oil will fall in 2008 from its current level of about $93 a barrel.

Behind the predictions: a slowing US economy and stronger production from both OPEC and non-OPEC sources. In addition, tensions with Iran seem to have eased somewhat, and the supply of oil from northern Iraq appears to be better. Increased production of ethanol and biodiesel will also help.

"Next year, we will probably be in a range of $80 to $85 a barrel," says Rick Mueller, an analyst with Energy Security Analysis of Wakefield, Mass. "And if the US goes into a recession, the price forecast will be lower."

If the price does stay in the $80 to $85 range, it will still be higher than the average price for 2007, which was closer to $71 a barrel.

The prospect of oil remaining under $100 a barrel could help the economy, says Bob Gay, managing partner of Fenwick Advisers, based in Rye, N.Y. "It takes a little pressure off the consumer," he says. "Beyond $100 a barrel is a delicate spot."

Indeed, lower oil prices could help ease cost pressures, since most measures of inflation have been pumped up recently by the rising price of food and energy. The increases have troubled the Federal Reserve, which is trying to balance the need for the economy to grow with the need to keep inflation in check.

Although there is optimism that oil prices will fall, energy analysts caution that a colder-than-normal winter could change the dynamics. "The most recent forecast is for the weather to be cooler into early January but later in the month to be warmer than normal," says Mr. Mueller.

Higher energy costs are eating into consumers' pocketbooks. The Energy Information Administration (EIA) estimates that the average household's winter heating bills will be about $2,000 – some $500 higher than last winter. Also, consumers this year paid an average of $2.83 per gallon for gasoline, according to EIA.

"Energy costs are probably shaving a quarter of a percentage point off gross domestic product as consumers have to spend more on energy," says Mark Vitner, senior economist at Wachovia Economics Group in Charlotte, N.C.

Even if the winter is somewhat colder, the energy markets may have a greater supply of oil next year. Through much of this year, OPEC production has been about 1 million barrels per day lower than expected, says John Felmy, chief economist at the American Petroleum Institute, a trade group in Washington. But he adds, "I have heard that Saudi Arabia is now pumping an extra 400,000 barrels of oil per day, so we'll have to see if that continues."

In fact, supply could outstrip demand next year, says Kevin Lindemer, an energy analyst at Global Insight in Lexington, Mass. This year, oil production was about 85 million barrels per day, barely enough to satisfy demand of about 85.7 million barrels per day. "Next year, we're probably closer to supplies of 87 million or 88 million barrels per day," he estimates.

Some of the new supply will come from Saudi Arabia, which is opening up another oil field, says Antoine Halff, an energy analyst at Fimat USA, an energy trading company in New York. "We see more production coming onstream next year, more rebuilding of spare capacity that will put some flexibility into the system," he says.

Spare capacity will also come from non-OPEC sources, says Mueller. "There are a number of big projects coming onstream in the US Gulf of Mexico, Brazil, Russia, and Kazakhstan," he says.

Energy supplies will be further augmented by an increase in biofuels. In 2007, EIA estimates, ethanol has been equal to 4.3 percent of the total gasoline pool. "We should be ramping up to 9 billion gallons of biofuels, up from 6 [billion] to 7 billion gallons right now," says Mr. Felmy.

In the past, US gasoline prices have climbed in the spring because of shortages in refining capacity. Mr. Halff worries about another spike this coming spring, since many US refineries are due for maintenance. "This past summer, there was a shortage of gasoline because of refinery problems, and that might repeat itself," he cautions.

But next year, some new, large refineries will come onstream overseas, and some of their product will be shipped to the US, predicts Mueller. A new refinery in Saudi Arabia will produce more than 1 million barrels of gasoline per day, and a new refinery in India will produce 600,000 barrels per day. "Most of the new production is export-targeted, mainly to the US and Europe," he says.

Yet gasoline exports from China could slow considerably, estimates Paul Ting of Paul Ting Energy Vision in Short Hills, N.J. "China had domestic problems in terms of mispricing the product this year," he explains. "So, since prices in China remained dormant but increased around the world, refiners held back refinery runs and increased exports since it was more profitable."

In 2008, however, he thinks the Chinese will allow product prices to rise so refiners are more willing to meet domestic demand. He estimates that China's thirst for energy will grow by 6 to 7 percent next year as long as the US economy does not go into a recession.

"If the US is crashing and burning, there could be a domino effect on the Chinese economy," Mr. Ting says.

Energy analysts warn that oil prices can be greatly affected by what happens to the US economy. In 1998, for example, the US slumped and the price of oil fell by 50 percent, recalls Mueller.

If the price of oil cools, the Chinese government might become a major buyer to fill its strategic petroleum reserves (SPR), which are under construction. "It is no secret they want to accumulate oil for their SPR for energy security," Ting says. "They didn't do much this year because of the high prices, but next year that may change if prices come down and they complete the construction of the SPRs."