When oil was at $65 almost no one believed it would double. There were a few nuts making the case, but they were ignored like Galileo was when he said the Earth moved around the Sun.
Now, it is hard to find analysts who do not believe oil is going to move over $140 a barrel, and, perhaps above $200. Their reasoning is sound enough. Demand in emerging nations like China and India is still increasing. While crude use in the US may be off slightly, it in not off enough to matter. Suppies may be drying up as fields in the Middle East, Mexico, and Russia age. A political catastrophe in Nigeria or Venezuela could cut production.
Against all that, a case for a sharp drop in oil prices is quietly forming and its logic is powerful but poorly understood.
The first argument that oil is too high is that it has been pushed up in part by speculators rushing to cover bets that crude will fall. It is a bit like a "short squeeze" in stocks. Once the "covering" is done, oil prices will face less pressure on the up side.
Perhaps the strongest rationale for a drop in crude is that supply is more abundant than it seems. Petróleo Brasileiro has found what is probably the largest deposit of crude uncovered in the last 40 years. According to The Wall Street Journal, the field could "contain about 33 billion barrels of oil." In the US there are debates about letting oil companies drill on previously protected land and offshore locations. In addition, technology advances are helping get more oil out of aged deposits.
In Asia, particularly China, the governments are not willing to subsidize gas and diesel prices, at least to the extent they have in years past. State-owned companies would buy crude at high prices and then sell the by-products dirt cheap to keep cars and trucks on the road. It was a way to fuel economic expansion, but the practice is becoming too expensive as crude sits above $130. If fuel prices in China and India move up as the central governments back off, demand will drop, perhaps by a lot.
The reasoning about tapping biofuels, solar energy, and increased use of nuclear and coal to cut oil demand has been around for nearly a decade. When oil was at $50 no one thought that these businesses could do well. Either the technology was too new, or citizens would not accept reactors filled with uranium sitting just a few miles away. But, the sight of the gallows focuses the mind. Paying $100 to fill-up a car with gas has started to become a real hardship.
The Sun moved around the Earth until it didn’t. Oil will go up until it doesn’t.
Douglas A McIntyre