Oil futures fell below $89 per barrel Tuesday (February 5) as concerns over recession gripped Wall Street.  Many economists believe that oil saw its peak after a brief stint over $100 early last month.  The major catalyst for Tuesday’s drop was a surprising report that showed the generally strong service sector may be weakening, indicating a dwindling demand for energy is on the horizon.

Another contributor to the drop in oil prices is market expectation that supplies of crude oil are likely to increase in the near future.  In fact, estimates are that last week’s crude oil supply saw a 2.6 million barrel increase over the prior week.  Simply supply and demand economics says if demand for energy is likely to fall and supplies of crude oil are likely to go up, price will go down.

The national average price for a gallon of unleaded gasoline is currently $2.977.  Many are predicting that gas prices will reached a record average around $3.50 this spring.  There is also talk of highs topping $4 per gallon in some parts of the United States in the summer.

Slowing economic conditions combined with less demand for energy would likely prevent such a move that soon.  Many market experts are point out that oil futures investors or short selling oil, meaning they are betting the price of oil is going to drop in the near term.

The potential for lower gasoline prices than originally anticipated is obviously good news for the average American.  The late spring and summer months are traditionally strong travel months for Americans.  Lower gas prices would certainly help stimulate the desire to travel and shop for consumers, which would certainly benefit the economy.  Exxon Mobil reported a record quarter profit for the fourth quarter of 2007.  This suggests oil companies are certainly benefiting from the high prices at the pump.

While lower gasoline prices definitely benefit consumers in the short-term, some economists believe this is a minor concession in the bigger picture.  Lower gasoline prices are likely tied to a struggling economy and a floundering service sector.  Therefore, if Americans do have to sacrifice a few dollars to buy fuel, they might be benefiting from a stronger economy in other ways, including housing prices, income, job opportunities, and more.

Lower oil helps Americans in other ways.  In the midst of a busy winter season that has included record snow fall and temperatures in many parts of the country, many Americans are paying higher energy bills as their furnaces struggle to keep up.  Lower oil usually brings lower natural gas prices.  Thus, a signs of higher crude oil supply is welcome news to home owners.

A recent report by the Energy Information Administration (EIA) contradicts the notion that oil is beginning a downward trend.  The report suggests that oil is not likely to fall much below $90 anytime soon.  The report looks at US offshore oil costs of around $70, which is high, and suggests that for reasonable profit margins to be had, the market is likely to pay over $90 per barrel.

Americans are certainly hopeful that gasoline and other energy costs remain low.  However, financial experts are also leery about what significant drops in demand and prices in the service sector means for the broader economy.  The service sector has held up strong up until this point, in spite of other sectors showing signs of a potential recession.  Today’s surprise report tightening in the sector came during expectations of modest growth.  As recession fears penetrated the sturdy service sector, financial markets reacted, sending the Dow, NASDAQ, and S&P all down about 3% on the day.

Market Recap

The Dow eased up a bit in Monday’s trade following last week’s strong move up.  The index was down by 108 points on the day.  The NASDAQ and S&P were also off 30 and 14 points, respectively.  Higher factory orders for December were uplifting from an economic perspective.  However, with little other significant market news, many investors chose to sell to collect profits from the recent move.  The markets went into free fall Tuesday due to severe profit taking, with the Dow falling 370 points on the day, to close at 12,265.  The NASDAQ and S&P both lost an incredible 3% of their index value.  Disney earnings topped expectations.  Oil dropped below $89 as recession fears reentered the market.

Neil Kokemuller
Tuesday, February 5, 2008
5:52 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA.  He has a MBA from Iowa State University with a specialization in marketing.

Please note:  The information provided in this article is intended for informational and entertainment purposes, and not as advice for financial decisions or investments.  Actions taken on the basis of the information shared is at the sole risk and discretion of the individual.  Currency investment poses significant risk of loss.