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How Low Can Oil Prices Go?

Economic Trends


Some analysts see more weakness

To U.S. consumers, whose heating oil bills have plummeted and who are paying as little as $1 or less for a gallon of gasoline at the pump for the first time in recent memory, it's like money in the bank. To commodity traders and analysts, it's a move whose sharpness and speed few anticipated. And to economists, it's a potent new development to factor into their forecasts of economic growth and inflation.

Since October, oil prices on world markets have plunged by a third, dipping below $14 per barrel for the first time in a decade and touching record postwar lows in real terms. And though global stocks of oil almost never rise in the first months of the year, they seem likely to surge by a heady 1.3 million barrels per day in the current quarter, says energy analyst Michael Rothman of Merrill Lynch & Co.

A number of factors are contributing to the latest downward price spiral. On the demand side, the most obvious is the turmoil in Asia, which has slashed consumption by some 500,000 barrels per day, and which may not be resolved for many months--or years--to come. In addition, both Europe and North America have experienced unusually warm winters. The U.S. government reports that the first two months of 1998 were the warmest on record in the lower 48 states.

On the supply side, the OPEC cartel actually boosted its production quotas last November, and several members, notably Venezuela and Nigeria, continue to exceed their quotas. And the U.N. is now in the process of raising Iraq's limit.

As for the economic fallout, economists at Salomon Smith Barney estimate that the recent decline in oil prices, if sustained, could reduce consumer inflation in Europe and the U.S. this year by 0.25% to 0.5% from where it would otherwise be. Lower prices also could add about 0.25% to economic growth, cutting the anticipated contractionary impact from the continuing Asian crisis by a quarter to a half.

Not everyone will benefit from lower oil prices, of course. For oil exporters, in OPEC and out, the price drop is a heavy blow. And the collapse of Asian currencies means that for some Asian countries, the price of oil imports has actually doubled or tripled in the past year.

The futures market suggests that oil prices will recover some ground later this year. But energy analyst Richard Redash of Prudential Securities Inc. argues that the disarray in OPEC ranks, the growth in non-OPEC output, and continuing technological advances that are slashing the costs of finding and producing oil (BW--Nov. 3) all suggest that the market still hasn't hit bottom.

Merrill Lynch's Rothman agrees. Without a production cut enforced by OPEC or some geopolitical disturbance that affects the availability of oil, he says, "it's entirely possible that we could eventually see prices retest their 1986 lows of $10 per barrel."BY GENE KORETZReturn to top

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Price swings aren't out of line

With the Dow bobbing up and down like a yo-yo in recent years, Wall Streeters have come to believe that increased volatility is an unavoidable feature of today's buoyant market. In point of fact, however, the increased volatility that's raising anxiety levels is illusory, concludes a new study by G. William Schwert, a professor at the University of Rochester's William E. Simon Graduate School of Business Administration.

Schwert studied U.S. stock indexes at monthly, daily, and intraday intervals and found that returns on investments in any of these time frames over the past decade were not especially volatile by historical standards. Volatility stayed high for a short while after the 1987 crash but then returned to normal levels, Schwert's data show. Only one day in the 1990s--last Oct. 27--made the lists of the top 35 percentage falls or top 35 rises from 1928 to 1997. That day ranked as the 17th-largest stock market decline. Most of the biggest changes were in the early 1930s.

Why do many traders believe that markets are volatile? One likely reason is that they haven't gotten used to the higher levels of the major indexes, in which small percentage changes produce big point swings, says Gregory van Kipnis, chief executive of Invictus Partners, a New York investment manager. When the Dow doubles in just three years and quadruples in a decade, a 100-point rise or drop in a day isn't what it used to be.

Another reason may be a growing appetite for leveraged trading. Some Wall Street firms, says Schwert, may be taking big risks in markets, so that even modest volatility seems scary to them.BY GENE KORETZ By Peter CoyReturn to top

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