The latest number-crunching by the EIA led the agency to forecast lower oil prices. (image: piratesmath.com)

The Energy Information Agency has modified its forecast for oil demand and supply in 2010, as reported by Reuters on Tuesday. According to the EIA, world oil consumption is expected to rise by 1.1 million to 85.22 million barrels per day next year; that number is lower than the EIA’s earlier forecast, which said that consumption would rise by 1.26 million to put global daily consumption at 85.40 million barrels. The EIA also said that it expects supply from both OPEC and non-OPEC oil producing nations to slightly increase.

Oil prices are predicted to be $1 lower than previously forecast; the EIA now thinks that oil will cost an average of $75 per barrel this winter. This corresponds with the EIA’s new estimates suggesting growing supply and shrinking demand. But nothing is ever simple in the oil industry, and predictions about the future of oil prices vary widely. Despite the EIA’s latest revisions, the agency has maintained its forecast that the average price of one barrel of crude will increase to $82 next year.

(image: marketoracle.co.uk)

If you’re the type of person who enjoys unhappy paradoxes, here’s a real pearl: persistent confidence in the global economy may actually be hurting the global economy. Fatih Birol, chief economist of the International Energy Agency, warned Reuters on Monday that rising oil prices, which are in part caused by optimistic traders convinced of a revived market, threaten to undermine the world’s financial recovery. If you’re the type of person who finds such paradoxes irksome or downright confounding, you are advised to skip the rest of this article.

The price of oil has more than doubled since the end of 2008, when the global financial system collapsed and a barrel of crude sold for only $30. Since then, many investors, eager to get things moving again, have eyed the economy for signs of recovery, perhaps mistaking strong financial reports from several bellwether companies for an indication that everything is well again. After all, increased business worldwide would mean a greater demand for oil, which in turn would mean that traders could begin selling commodities for more money. Discontent to wait for the sluggish market to pick up, some traders have already begun selling oil long, despite consistently low demand.

However, analysts have warned that driving up oil prices will ultimately hinder economic growth. As an article published last week by Fortune put it, higher energy and oil prices “could complicate recovery in an economy that, despite the tumult of the past two years, remains as consumer-driven as ever.” It doesn’t take an economist to spot the dampening implications of decreased consumer spending; when Americans expend 6 percent of their income on energy costs, they have less to spend on other goods and services. It seems no coincidence that as fuel prices rose 6.3 percent last month, the Consumer Price Index indicated that consumer prices for October were higher than last year despite numerous price declines. Given the recession, this figure does not bode well for economic recovery.

Birol has joined a chorus of concerned financial analysts decrying inflated oil prices and their threat to economic recovery. None other than Nouriel Roubini, who in 2006 foretold of the global economic crisis and the unraveling of the housing market, has warned that skyrocketing oil prices spell doom for the global economy. “The price increase we have seen is too much, too fast,” Roubini said at a commodities conference in New York earlier this month. “If oil goes to $100 today, it will have the same effect on the global economy as what $147 oil had last year,” he said, referring to the staggering price of oil just before the US financial crisis escalated into a global recession in 2008.

In a recent report, the IEA suggested that the run-up in oil prices between 2003 to mid-2008 played “an important, albeit secondary” role in the global economic downturn, as higher oil prices made oil-importing countries more vulnerable to the financial crisis. With Roubini-like prescience, the agency predicted in 2006 that inflated oil prices would “pose a significant threat to the world economy, by causing a worsening of current account imbalances and by triggering abrupt exchange rate realignments, a rise in interest rates and a slump in house and other asset prices.” Given that oil prices have reached $80 per barrel, this is not a heartening thought.

Daniel Yergin joins other commentators who have said oil prices are not being driven by supply and demand. (image: cache.daylife.com)

“Oil prices today do not reflect the world’s supply and demand fundamentals.” That, in a nutshell, is energy expert Daniel Yergin’s assessment of why today’s $80 a barrel oil prices are double that of last year’s. On Monday Reuters reported that Yergin—who was awarded the Pulitzer Prize in 1992 for his book on the history of the global oil industry entitled The Prize: An Epic Quest for Oil, Money, and Power—attributes current oil prices to the weakness of the dollar and an overriding faith in economic recovery.

Yergin, who also possesses a PhD in International Relations from Cambridge and is the chairman of IHS Cambridge Energy Research Associates, Inc., agrees with many other renowned energy experts concerning the price of oil. On November 13 HeatingOil.com reported that energy expert Jason Schenker attributes the abnormally high cost of oil to optimistic investors who trade as though the economy is rapidly recovering and oil demand is high.

Commodities trader and analyst Stephen Schork, who is known for his unorthodox opinions on oil production and consumption, also agrees that oil prices are out of sync with supply and demand. However, Schork adds an interesting psychological element to interpreting the price of oil. According to HeatingOil.com, Schork attributes the price of oil to unfounded American beliefs that other countries, especially China, have begun consuming oil at unprecedented rates. The way Schork puts it, “the idea of a billion Chinese trading their Schwinns for Cadillac Escalades—I think that is what is driving the market.”

Also agreeing that oil prices are inconsistent with the laws of supply and demand is economics professor Nouriel Roubini. Professor Roubini has warned that such high prices are dangerous to economies that are only now beginning to shake the effects of last year’s economic crisis. Roubini, who predicted the crumbling housing market and subsequent credit crisis in 2006, has argued that what recovery has been achieved is in danger and “if oil goes to $100 today, it will have the same effect on the global economy as what $147 oil had last year.”

The current state of affairs surrounding oil prices has not shaken Dr. Yergin’s faith in supply and demand, though. Asserting that “the only two real characters that count are supply and demand,” Yergin is confident that the market will eventually correct itself, and that supply and demand “will win at the end of the day.”

And although Yergin’s analysis of crude oil prices is not entirely positive, he may have good news for consumers of diesel fuel and heating oil. According to Yergin, supplies of diesel and heating oil are remarkably abundant—when the market does correct itself, customers will receive significantly lower prices.