Energy Journal VII

As global economic conditions continue to deteriorate, oil prices have slipped to lows not seen in over a year. For some, this is seen as a justification for the idea that prices were inflated by speculators or market manipulation this past summer. However, the loss is more a reflection of recessionary fears than and does not change the proposition that energy is becoming less cheap and more expensive.

The chart to the right tracks the S&P 500 and the price of crude oil since January 1, 2008. The indexed values are correlated (correlation coefficient = 0.524) but this number does not tell the entire story. From May to July, stock and oil prices were largely decoupled. The S&P trended down while oil reached record highs. Since August, the indexed values are more highly correlated (0.944) as both oil and securities lost substantial value as the credit crisis worsened.

Reduced gasoline prices offer a test for domestic consumers. As prices rose to over $4.00 per gallon, many consumers changed their driving habits to save money. The respite from high prices will test the conservation measures enacted by domestic consumers. Many wonder if consumers will continue to conserve or if old patterns will emerge.

One of the main mitigating factors is the faltering global economy. Job losses and recession fears in the United States have weighed heavily on the rest of the world, leading to a large-scale reduction in demand forecasts for both developed and developing nations. The assumption is that reduced consumer spending in the US and Europe will depress growing economies in China, India and elsewhere. Growth in these economies has been predicated by robust borrowing in the United States. Now that less capital is flowing out of the United States, manufacturing gains have slowed or reversed themselves. OPEC and other oil producers assume that this will result in decreased demand for crude oil in both manufacturing and domestic arenas.

This kind of price movement is logical. However, it is emblematic of short-term thinking regarding the supply and demand fundamentals of crude. Some of this is due to the nature of forward contracts – they have a finite term and reflect current market realities. However, the long-term supply and demand fundamentals for oil have not changed. Once the global economy resumes robust growth, the price of oil will rise. Demand from developing nations will reemerge and outpace production.

Another more subtle concern is for alternative energy projects. High oil prices made these investments financially viable. Some worry that declines in prices will cut off investment in these projects, as the present value will no longer exceed fossil fuels. It is imperative for our national energy program that investment continues to flow into alternative energy and that consumers remain vigilant in conserving oil consumption. Long-term fundamentals (namely that oil is a finite resource and that global demand will rise when economic conditions improve) have not changed. Only the short-term market conditions have shifted.

Our country is in the midst of an unprecedented financial crisis. Because of the increase in global interconnectedness over the past decade, problems here impact the rest of the world on a scale not seen before. It is entirely logical and proper for oil prices to fall in response to these factors which reduce demand. However, the same factors which have caused the global economy to falter will also act in concert when the recover begins and oil demand increases. Consumers, governments, and investors should not lose sight of the long-term implications of expensive energy and plan accordingly. This decrease in prices serves as a brief respite within which we can correct habits, build infrastructure and cement lasting change in how we view resource consumption. While economic concerns currently dominate our national dialogue, we need to continue making the best choices for our long-term energy and environmental needs.