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What's Really Driving Oil Down These Days

Wednesday, 03 Sep 2008 12:36 PM

Hurricane Gustav struck the oil-rich Gulf of Mexico with a vengeance, causing oil companies such as Exxon Mobil, Chevron, and Royal Dutch Shell to shut down their production of crude oil there.

In fact, the U.S. Minerals Management Service reported that approximately 75 percent of crude oil production in the Gulf of Mexico was shut down during the past few days because of Hurricane Gustav. That's an important development; approximately 25 percent of the crude oil produced in the United States comes from the Gulf of Mexico.

Although Gustav failed to destroy any oil rigs or production platforms, three more tropical storms, which could become hurricanes, are currently stirring in the Atlantic, named Hanna, Ike, and Josephine. Yet, the price of West Texas Intermediate Crude Oil fell $5.75 on Sept. 2 to $109.71 per barrel. That's the first time that crude oil prices have traded below $110 since April 8.

So, what's behind the big drop in oil prices? The answer's really quite simple: The demand for oil has fallen significantly over the past few months, while the exchange-value of the U.S. dollar has rallied sharply against other world currencies.

(Some of you may recall that I forecast such a development back in May of this year when many of the so-called "experts" were forecasting oil prices to rise to $150, and perhaps to $200, per barrel by the end of this year.)

With economic growth continuing to slow throughout many regions of the world, I expect the demand for oil to continue to fall during the months ahead. The Minerals Management Service (MMS), which is the government agency that manages U.S. oil resources, agrees with my forecast. The service expects U.S. demand for petroleum products to decline by 500,000 barrels per day this year, from approximately 20.7 million barrels per day in 2007, "on prospects for a weak economy."

According to the MMS, petroleum consumption declined by 900,000 barrels per day from the beginning of January to the end of May, from 20.71 million barrels per day during the same period a year ago, the biggest decline in U.S. petroleum consumption in 26 years.

I also expect the dollar to continue its ascent against other world currencies in response to slowing economic growth in Europe and Asia, and as U.S. economists pressure the Fed to fight inflation by raising short-term interest rates. The dollar has already appreciated 9 percent against the euro since mid-July and 7 percent against a basket of other major currencies.

Earlier today, the Fed announced that three of its 12 Federal Reserve Bank presidents voted on July 24 to raise the federal funds rate by 0.25 percent during August. Unfortunately, two of those bank presidents are currently not members of the Fed's Open Market Committee, which determines monetary policy.

As a result of the developments mentioned above, stock market participants bid up the prices of U.S. equities, with the Dow Jones Industrial Average rising more than 240 points during the morning session Tuesday, Sept. 2. However, stocks sold off later that same day as astute investors realized that the U.S. economy will likely continue to grow at a sluggish pace over the foreseeable future.

I therefore urge you to not get too excited about today's drop in oil prices. Even if crude oil prices fall another $20 per barrel and retail gasoline prices decline to $3 per gallon, the average U.S. consumer will still remain highly in debt, and many so-called "homeowners" will remain upside down in their mortgage, that is, the debt owed on their home mortgage will be higher than the value of the home that they mortgaged, and, finally, the employment situation will likely continue to worsen over the next several months.

On a brighter note, my research indicates that the housing market has now bottomed, and that the credit crunch is nearing an end. I therefore expect the U.S. economy to improve significantly during the second half of 2009.

Click here if you'd like to learn how to profit from those developments by investing in the right sectors of the market at the right time.

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DavidFrazier
Hurricane Gustav struck the oil-rich Gulf of Mexico with a vengeance, causing oil companies such as Exxon Mobil, Chevron, and Royal Dutch Shell to shut down their production of crude oil there. In fact, the U.S. Minerals Management Service reported that approximately 75...
david,frazier,oil,price
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2008-36-03
Wednesday, 03 Sep 2008 12:36 PM
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