MAKING SENSE OF OIL PRICES

Americans are paying attention to gasoline price spikes in the aftermath of Hurricane Katrina and as Hurricane Rita arrives in Texas. Many are confused by a market where bulk purchases are made based on what prices are expected to be months in the future.

Here’s what’s clear: For now, there’s enough oil to go around, so prices fell since the panic caused by Katrina. After spiking to a record $70 a barrel immediately after the hurricane, oil was trading at around $64 a barrel a week ago before heading back up as Rita headed for shore.

A larger problem than petroleum supply is turning that oil into gasoline, heating oil and other useful distillates because many oil refineries were knocked out of operation in the Gulf Coast. As the refineries are repaired, this problem has eased, although the damage expected from Rita could reverse those gains.

Adequate supply was one reason for the oil price drop, decreased demand is another. The high oil and gas prices of recent weeks have caused people to use less. Gasoline consumption fell for the third week in a row, according to the Energy Information Administration. U.S. gasoline consumption last week was at its lowest level since February 2004. With gas over $3 a gallon, Americans decided they would drive less and gasoline prices then fell. In the words of the EIA, the gasoline system was “moving back toward equilibrium.”

Heating oil is following a similar pattern – although prices have dropped slightly from their post-Katrina highs, prices are expected to be about one-third higher than last winter. Higher crude oil prices and increased international demand for diesel, which is similar to home heating oil, are behind the price jump.

The outlook for natural gas is worse. Due to increased demand, particularly from utilities that use natural gas to generate electricity, and limited supply, natural gas prices are predicted to rise 70 percent this winter. That means higher heating bills for those who use natural gas for their furnace.

While recent oil and gas price drops are good news for consumers, there should be concern that the current tenuous balance could easily shift beyond the expected spikes following Hurricane Rita. Worldwide petroleum demand growth is projected to about 1.7 million barrels a day in 2005 and 2006, a 2.1 percent annual average increase over 2004.

Yet, little growth in oil production is expected. Non-OPEC supply is projected to increase by an annual average of 0.7 million barrels a day during 2005 and 2006. More troubling, worldwide spare production capacity is at its lowest level in three decades at about 1 million barrels a day.

In the long term, that means that demand will exceed supply leading to higher prices, which will dampen demand.

If you want to know more, the EIA, a branch of the Energy Department, provides a wealth of information at http://www.eia.doe.gov/. “This Week in Petroleum,” released on Wednesdays, provides a narrative account of the past week’s activities and predictions about the future. The report also offers links to specific information about gasoline, propane and other distillates.