Oil Prices: Down and Heading Lower

The worst oil spill in U.S. history was not enough to prevent crude oil prices from falling nearly 10 percent over the past three months—the first quarterly drop since 2008—as the sluggish world economy kept a lid on demand. With growth expected to remain weak, prices may keep moving lower through 2010. "Getting out of the worldwide recession was always going to be a long slog," says Adam Sieminski, chief energy economist at Deutsche Bank (DB) in Washington, who predicts oil will average $65 a barrel in the third quarter and $70 in the fourth. "It's always been our view that the second half of 2010 was going to be a tough period." Crude oil ended the month of June at $75.63 a barrel.

Anemic global growth led the U.S. Energy Dept. in June to trim its crude oil demand and price forecasts for 2010. World demand will average 85.51 million barrels a day this year, the department estimates, up from 84.01 million barrels last year; global demand peaked at 86.14 million barrels a day in 2007. The department's latest forecast calls for West Texas Intermediate oil to average $78.75 a barrel this year, down from the May forecast of $82.18.

The sinking of the Deepwater Horizon rig on Apr. 22 hasn't changed the supply/demand equation. In response to the accident, the Obama Administration in May imposed a six-month moratorium on deepwater drilling permits. A federal judge lifted the order on June 22, and the Administration is appealing. If the moratorium is reinstated, U.S. crude output will be cut by an average of 26,000 barrels a day in the fourth quarter of this year and 70,000 barrels a day in 2011, according to the Energy Dept.—an amount equal to less than 1 percent of daily global oil production.

"Supplies are certainly adequate given the weakness in Europe and elsewhere in [developed nations]," says Addison Armstrong, director of market research at Tradition Energy, a procurement adviser. "Whatever will be lost here because of the moratorium...will be more than offset by OPEC spare capacity." OPEC still has the ability to pump an additional 5.46 million barrels a day.

Of course, energy markets are subject to sudden shifts. The summer driving season might push up prices, and there's always the chance that an active hurricane season could disrupt production, further curtailing supply. The fragile state of the world economy, though, remains the dominant force in the market. "The underlying fundamentals haven't changed," says Rick Mueller, director of oil markets at Energy Security Analysis in Wakefield, Mass. "There will remain a tremendous amount of crude available."

The bottom line: The biggest oil spill in U.S. history is having less impact on prices than weak global demand and spare OPEC production capacity.

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