Is Cheaper Oil A Good Thing?

How far can it fall? People have been anxiously wondering as they watch the plunging stock market. But increasingly the same question is being asked about another crucial figure: the price of oil. It has plummeted nearly 40% in just three months, from about $147 a barrel in July to below $83 on Friday, with no obvious bottom in sight. If that sounds good, you are probably a driver who winces these days at filling your gas tank. But the downward spiral could mean trouble for oil-rich countries and for the environment.

Oil analysts admit that most of them failed to predict how fast oil prices would drop. Just a few months ago, some were saying oil might reach $200 a barrel by year's end. "The analysts have been quite surprised by the pace and volatility of the decline," says David Fyfe, senior oil analyst for the International Energy Agency in Paris, which as a rule does not predict oil prices. "The volatility has been quite marked."

This year's sky-high oil prices are partly responsible for the drop. Since oil hit $100 a barrel for the first time early this year, Americans (who consume one-quarter of the world's energy) began cutting back. When gas began selling above $4 a gallon, American consumers made "a psychological shift into the sense of crisis and a sense of permanence," says Greg Priddy, oil analyst for the Eurasia Group in Washington. Instead of believing that gas prices would finally fall again, many began changing their daily habits — they started driving the smaller car in a two-car garage or consolidating shopping trips. That has meant a huge slump in Americans' gas use. Even before the market meltdown, Americans consumed 800,000 barrels of oil a day less during the first half of this year than the same period last year. As demand fell, so did prices, and as prices have fallen, investors have begun pulling money out of the oil market, fearing a collapse, says Leila Benali, an expert on Middle East oil for the Cambridge Energy Research Associates in Paris, adding: "People are getting nervous about demand next year. There is talk of a global recession."

For oil-rich countries the slump has come at a bad time. As the oil price began rising during the past few years, governments and big oil companies plowed billions into exploring and developing new fields in Russia, Angola, Mexico, Brazil and Saudi Arabia — projects whose costs have more than doubled in the past few years, in part because soaring steel prices drove up drilling equipment costs and oil-rig rentals. Just as global demand has begun to slow, millions more barrels of oil a day from new fields have hit the world market.

The big oil producers have good reason to be nervous. Many are still haunted by a disastrous error made at an Opec meeting in Jakarta in 1999, when the cartel — which produces more than a third of the world's oil — opted to raise its production levels. Within weeks Asian stock markets tumbled, driving world oil prices down to $11 a barrel. Oil officials in Saudi Arabia and elsewhere have cited that price crash as the reason they've rebuffed pleas from President Bush to pump more oil. Says Benali: "Countries have learned the lessons of the past."

Though oil-producers and environmentalists rarely agree about anything, both groups have done extremely well from sky-high oil prices during the past year. The high price at U.S. gas pumps has pushed both Barack Obama and John McCain into making the development of alternative fuels and electric cars key elements of their campaign platforms. But if gas prices continue to drop, those initiatives might begin to seem unnecessarily costly to many Americans. (Time's Bryan Walsh reported this week that some countries are already reviewing environmental initiatives as gas prices fall.) "If gas prices drop under $3 a gallon, it will be interesting to see whether it saps the political will," says Priddy. "Americans like their sprawl and generally don't like to give those things up."

If oil producers have their way, oil prices could start rising again. Their growing anxiety erupted early this week, when Iranian and Venezuelan officials warned that if Opec waited much longer before cutting its output, it could face another massive price collapse. On Thursday, Opec officials scheduled an emergency meeting in Vienna for Nov. 18 rather than wait until the cartel's scheduled summit in Algiers in early December. In the meantime, the world's biggest oil producer, Saudi Arabia — which increased production in the summer — has already begun loading less oil on its tankers, according to global oil figures.

For some countries there is a fear far greater than an economic recession: political turmoil. Iran, which earns 80% of its revenues from oil exports, set this year's budget on the assumption that oil would trade at $90 a barrel — a figure which seemed conservatively low until recently, but which is now above the world price. "If the price stays there a while Iran would cut spending," Priddy says. That might include cutting heavy gas subsidies for Iranian drivers, who have rioted in the past when the government tried to ration gas or raise the price at the pump. Hugo Chavez could face similar problems in Venezuela if oil prices drop below $75 a barrel — the rate at which the country calculated this year's budget. The problems lower prices could cause in those countries could be more visceral than those posed so far by the current financial upheaval.