On Friday, October 10th, the price of oil fell below $80.00 to $77.85 a barrel. This is the first time, within the last 12 months. that the price has fallen below $80.00 a barrel. The drop was accredited to an expected decline in demand stemming from the world economic crisis, and an expected subsequent drop in the world gross domestic product due to inflation and increasing unemployment. Gas prices at the pump have also been on a recent decline.

U.S. light crude for November delivery was also down by $6.74 at $79.85, its lowest since October of 2007. Economic weakness spurred the International Energy Agency to cast its forecasts for world oil demand growth for 2008 at its lowest rate since 1993. Prices have dropped nearly 45% from a peak of $147.27 in July. It has also lowered its 2009 growth forecast by 190,000 barrels per day.

Decreased demand in the United States and other large economy countries has caused a steep decline of oil prices that were at their peak at $147.27 a barrel in July. The price decrease has caused some OPEC members to call for a cut in production levels, and the cartel has agreed to hold an emergency meeting in Vienna on November 18 to discuss the impact of the global financial crisis on the oil market. OPEC decided to cut its production of 520,000 barrels of oil per day at its last meeting in September, to sustain oil prices above $100 a barrel.

Some countries in OPEC (The Organization of the Petroleum Exporting Countries) again called for a sharp reduction in production levels. They will meet in Vienna, Austria in mid-November with goal of producing that reduction. OPEC, the cartel of oil producing countries, is comprised of Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. Their influence on the market is, at times, controversial and in the past few years has been waning as oil producing efforts from Russia and the Gulf of Mexico have sub-planted them. OPEC still accounts for nearly two-thirds of the world’s oil reserves, and as of mid 2008, over 35% of the world’s oil production. The United States holds approximately 5% of the worlds oil reserves, but consumes nearly 25% of its resources.

Political conflicts between western nations and some OPEC member countries have produced an ‘oil as a weapon’ mindset in which rich oil producing countries, effectively, alternately withhold reserves or produce a pricing structure that makes its availability and price difficult for countries to absorb, driving up inflationary measures. With an ever increasing need for energy resources, and political and ideological conflicts growing significantly between the Arabic and westernized nations, the subject of foreign oil dependency has been deemed a national security issue and is driving the desire for energy alternatives. The future effects of the world financial crisis are expected to be far reaching with the likes of inflation, unemployment, high debt level increases, and a global slipping of gross domestic product.

Accordingly to Dr. Mark J. Perry, professor of economics and finance at the University of Michigan, world GDP, net oil exports, and oil prices were all increasing at about the same rate from 2002 to early 2006. Starting in mid-2006, the three entities started to diverge as world GDP continued to increase, while net oil exports started to decline. It was at that point of departure in 2006 between global output and the global supply of oil that oil prices started to rise significantly.

Although the decline of the dollar and the increase in speculative activity might have played roles– albeit minor– in the run-up of oil prices, the main contributing factor to high oil prices over the last two years appears to be the supply-demand imbalance that started in mid-2006.

Now that the world GDP is expected to decline the price of oil, already on a downtrend, is expected to fall further, or at least until OPEC countries reduce production levels to head off a complete free fall. As less demand becomes apparent, the costs will decline, but when oil production levels fall back in line with the new level of demand, they are expected to level off.

The graph shows that world GDP, net oil exports, and oil prices were all increasing at about the same rate from 2002 to early 2006. Beginning around mid-2006, the three entities started to diverge as world GDP continued to increase, but net oil exports started to decline. It was at that point of departure in 2006 between global output and the global supply of oil that oil prices started to rise significantly.

Source: Dr. Mark J. Perry, professor of Economics and Finance, University of Michigan