Oil prices drop back to reality

Reality returned to the oil market this week.

Oil has fallen 7 percent since last Friday, when the price briefly topped $100 for the first time in 4 months. The sharp drop was expected and overdue, many analysts say.

Traders had driven oil prices up by 30 percent since late June in anticipation of new measures from the world's central banks to boost economic growth. This week they woke up to some cold hard facts: there's no easy fix for the global economy, demand for oil is slowing and there's plenty of supply.

"It was hope versus reality," said Judith Dwarkin, chief energy economist at ITG Investment Research. "It was inevitable."

On Thursday benchmark U.S. crude steadied, slipping just 11 cents to finish at $91.87 per barrel. But it's more than $7 below where it closed last week. For drivers, that should mean lower gasoline prices, although the decline will be tempered by recent shortages in some regions.

Oil is sliding because demand is growing slower than expected. That's because economies around the world are struggling, including the three biggest oil consuming regions: the U.S., China and Europe. When economic growth falters, demand for gasoline, diesel and jet fuel falls as people travel less and ship fewer goods.

In recent years world oil demand has grown about 1.3 percent per year on average. This year and next, though, demand will likely grow closer to 0.8 percent, Dwarkin says.

At the same time, world oil supplies are plentiful. Production in the U.S., Canada, Iraq and Saudi Arabia has increased enough to make up for losses from Iran, Venezuela and elsewhere. The U.S. government reported this week that stocks of oil grew by 8.5 million barrels to 367.6 million barrels, which is 8.4 percent higher than last year.

Investors saw much of this — and still oil soared in August and early September. That's because central banks around the world took measures to reduce borrowing costs in hopes of stimulating their weak economies. When borrowing costs fall, more money is available to invest in assets such as oil and traders expect demand for oil to rise.

Also, continuing tensions in the Middle East raised fears of future supply shortages. Traders bought oil as a safeguard.

"There was a tug of war," Dwarkin said. One side was the expectation that geopolitics and stimulus programs would push prices higher. On the other side was the fact there is plenty of oil to meet demand.

Oil markets suddenly leaned to the downside this week. There were questions about how effective the Federal Reserve's latest stimulus program would be. Economic indicators from Japan, China and Europe were disappointing. And the U.S. government reported an unusually large increase in the nation's crude supplies.

Without a major disruption or surprising economic turnaround, the price of oil may drift somewhat lower in the coming months. Analysts don't expect it to fall sharply though. Dwarkin expects it to average $95 per barrel both this year and next.

The recent drop in oil won't ease concerns about jobs and wages. But lower retail gasoline prices in the U.S. are likely to follow.

"This is good for the consumer," said Tom Kloza, chief oil analyst at the Oil Price Information Service.

The drop in pump prices may be a little delayed in coming, though, Kloza said. A series of refinery problems has kept gasoline supplies in the Northeast and along the West Coast low, which is helping to keep national average prices high. The shortages are expected to ease in the coming weeks. Refiners are expected to be able to produce enough gasoline to meet demand that is in a seasonal trough, and weaker even than usual.

The national average retail gasoline price fell less than a penny to $3.85 per gallon, according to AAA, OPIS and Wright Express.

In other energy trading, Brent crude, which is used by refiners to make much of the gasoline that is sold in the U.S., rose $1.84 to end at $110.03 per barrel.

Natural gas rose 4 cents to finish at $2.80 per thousand cubic feet.

Heating oil rose 5 cents to end at $3.10 per gallon.

Wholesale gasoline rose 8 cents to finish at $2.90 per gallon.