Why Oil Prices Will Drop

Image: Reena De La Rosa

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If you haven't got the message that something disturbing is happening in the oil world, stop by my office. On my desk, I have a pile of books a foot high with titles like Out of Gas, The End of Oil, and Twilight in the Desert. The authors range from geologists to journalists to policy wonks, and they all tell the same story.

For years, oil industry executives dismissed fears of an energy crisis, attributing rising gasoline prices to unrest in the Middle East, Wall Street speculation, and temporary interruptions in supply. But recently, as the price of crude has bounced around $100 a barrel, even some establishment figures have been making alarmist noises. The Paris-based International Energy Agency warned of a possible "supply crunch" within five years. Its chief economist, Fatih Birol, said prices could reach such a high level that "the wheels may fall off" the global economy. In the U.S., the National Petroleum Council, a federal advisory group, said that as the economies of China and India continue to expand, global energy consumption will rise by 50 percent over the coming quarter of a century. "There is no quick fix," said Lee Raymond, former chairman of Exxon Mobil, who leads the council.

Perhaps not. But the experts who are predicting the worst, based on geology and geopolitics, are missing the crucial role that economic incentives play in determining the price of crude. The tripling of oil prices since the summer of 2003 has unleashed forces that within the next two or three years will bring oil prices tumbling back down to below $50 a barrel. Looking even further ahead, prices could easily fall to $30 a barrel or even lower. So before you trade in your Cadillac Escalade for a Toyota Prius, think twice: $1.50-a-gallon gas might not be gone forever.

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