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Old 09-19-06, 11:12 AM
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Blue Order
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Gas to drop to $1.15?

Why $1.15 Gas Isn't A Fantasy

Sure, it sounds far-fetched, but the pieces are starting to fall into place for what could be a dramatic drop in oil prices over the next few years.

Remember when you paid $1.15 a gallon for gasoline?

You could be paying it again. Maybe not this year, but perhaps in the next few years.

Sure, oil experts say there's little excess refining capacity. Oil reserves are stretched. Oil consumption is soaring in China and India.

But things are starting to change. Drivers are changing their habits. Global tensions are easing, and more supply is on its way.

Crude oil zoomed to nearly $80 a barrel this summer as traders fretted about waning supplies and two big potential problems: tensions over Iran's nuclear research program and Katrina-style hurricanes threatening oil production in the Gulf of Mexico.

To keep prices moving ever higher, traders needed -- and frequently got – a steady stream of bad news. "It was like you needed a fifth of booze a day to keep the buzz going," says Peter Beutel of Cameron Hanover, a Connecticut energy consulting firm.

But prices began falling a month ago when it became clear hurricane season wouldn't be anything like last year. Oil traders have come to sense, too, that all the saber rattling over Iran was dissipating. "We got everyone leaning the wrong way," Beutel said.

(In fact, a big hedge fund was forced to tell its investors this week that it would be taking a huge loss because it bet the wrong way on natural gas.)

Result: The spot price of crude oil closed at $63.23 a barrel in New York on Thursday, down nearly 18% from a peak of $77.03 a barrel on July 14. Crude rallied slightly on Friday and Monday.

AAA says the national average price of gasoline is $2.495 a gallon, down nearly 17% from peaks in August, and there are some communities in Missouri where it has fallen under $2 a gallon. Prices should moderate further in the coming weeks because the summer driving season is over.

The oil price break has forced everyone in the energy business to take a hard look at how much lower prices could fall. A lot lower, says Philip Verleger, a noted energy consultant who was a lone voice several years ago in warning that oil prices would soar. Indeed, he told McClatchy Newspapers last week, "All the hurricane flags are flying" in oil markets.

If everything falls into place, crude could drop perhaps even to $15 a barrel, Verleger says. And then, he says, you would see gasoline at $1.15. Here's how that could occur.

Oil and gasoline inventories continue to grow.
They've been building up all over the world as users and refiners have scrambled to ensure enough supply in case, say, the Strait of Hormuz in the Persian Gulf is shut down. Tankers from Iran, Saudi Arabia, Kuwait, Iraq and Gulf oil producing countries must pass through the strait to bring crude oil to the rest of the world.
The weather cooperates.
On top of a hurricane with few threats to the oil and gas fields in the Gulf of Mexico, weather cooperation means a warm winter like the winter of 2005-2006. That would drop demand for heating oil, a key heating source especially on the East Coast and in Europe. And that would create excess supplies of crude that refiners could use to make gasoline.
Tensions in the Middle East continue to ease.
This assumes conflicts between Israel and Hezbollah in Lebanon tail off and that Iran and the rest of the world come to an agreement over Iran's nuclear program. (Admittedly, the latter is a reason why the scenario could fall apart.)
Drivers take the bus.
There is anecdotal evidence that U.S. drivers are finding other ways to get around with gas prices above $3. The big question is if they will they climb back behind the wheel as prices drop.

Those four pieces are just the start. Beutel thinks two more catalysts are starting to emerge.

1. At current prices, Beutel says, "you can drill a lot of dry holes before you give up on a field." And so, drawn by the potentially huge profits, energy companies are finally starting to make plans to drill for more oil.

Example: the Jack 2 field in the Gulf of Mexico now being developed by Chevron (CVX, news, msgs), Devon Energy (DVN, news, msgs) and Norway's Statoil (STO, news, msgs). While the field is 7,000 feet under water and another 20,000 feet under the ocean floor, it's also huge. One report suggested it could boost current U.S. reserves by 50%.

Cambridge Energy Research Associates says some 360 additional drilling projects are now under way and global supplies could grow by some 25% by 2015.

2. Beutel thinks buyers are already demanding more fuel-efficient vehicles. "They're not buying SUVs," he says.

Not now anyway. But don’t write the Hummer’s obituary just yet. Beutel thinks that, at some point, prices will drop so low that Americans will get complacent and start driving big gas-guzzlers again. And the cycle will turn.

-- Charley Blaine
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