Don't expect oil prices to drop below $100 a barrel

HOUSTON -- Oil's meteoric rise to near $120 a barrel looks like more than just another economic bubble -- growing demand and tighter supplies are likely to keep prices high. Some analysts say even $200 a barrel would not be out of the question.

The latest price surge -- pushing crude to record heights in recent weeks, and to nearly double its level a year ago -- has some key components of a classic bubble, when market prices climb far above their intrinsic value. The burst comes when investors realize the assets are overvalued.

But growing worldwide thirst for crude, in large part from the rapidly developing economies of China and India, means frustrated consumers probably won't get any relief.

"We can do our homework, but prices are going to go where they want to go at this point," said Jeff Spittel, an analyst at investment bank Natixis Bleichroeder Inc.

Americans who hoped to ride out temporarily high prices by carpooling or driving less may have to make those habits permanent.

And because of the premium prices, oil companies may be willing to search out more oil in places they previously couldn't afford to explore.

Oil came close to $120 a barrel Friday on news that a ship under contract to the U.S. Defense Department fired warning shots at two Iranian boats in the Persian Gulf. The markets were also weighing the effects of a pipeline attack in Nigeria and a looming refinery strike in Scotland.

Retail gas prices, which at times rise in tandem with crude oil, moved further into record territory near $3.60 a gallon.

The Organization of Petroleum Exporting Countries -- which supplies about 40 percent of the world's crude -- insists it's supplying more than enough oil.

Instead, many observers blame speculative traders for bidding up the price as a hedge against inflation and as protection from the sinking U.S. dollar. Some see that as evidence of a bubble.

It's also becoming harder and more expensive for oil companies to find and tap new petroleum reserves -- a troublesome scenario given forecasts that the world's energy needs will escalate by more than 50 percent in the next two decades.

Toss in the weak dollar and political instability in some oil-producing countries, and it seems unlikely that oil will fall below $100 a barrel anytime soon, if ever.

Widely watched oil price prognosticator Goldman Sachs has said oil could average $110 a barrel by 2010, up from a previous forecast of $80, and that a spike as high as $200 a barrel is possible in case of a major supply disruption.

Supply is at the heart of soaring prices, said John Moroney, a Texas A&M economics professor who just finished a book on energy production and consumption. He cites production declines in Mexico, an unstable oil industry in Venezuela and possible shrinking production capacity in the Middle East.

"I don't buy the bubble theory," he said.

Many analysts believe the weakness of the dollar is a bigger factor than supply and demand because the soft dollar draws investors worried about inflation into commodities such as oil and gold.

It also makes commodities less expensive for buyers operating in other currencies. Many investors see the dollar only heading lower if the Federal Reserve keeps cutting interest rates, which most analyst still expect it to do next week.

Some market-watchers say oil will probably keep rising until demand falls off, which they describe as the market's way of finding fair value for the commodity. For oil, some estimate that price as low as $60 or $70 a barrel.

"The fundamentals don't justify anywhere near these prices, even when you factor in geopolitical problems," said Michael Lynch, president of Strategic Energy & Economic Research Inc. in Cambridge, Mass.

He expects prices to fall as low as $80 this year.

Demand already has begun to wane in the U.S., where fuel prices are causing turmoil in an economy already saddled with recession fears, a housing and credit crisis, and dismal retail sales.

Drivers have begun to cut back on gasoline consumption. Some people have taken to riding bikes to work or organizing car pools.

Sales of gas-electric hybrid vehicles are up. Larger trucks and sport utility vehicles are selling slowly.

It's unclear how much a drop in oil prices could reduce gasoline prices. The prices do not always move together because they are subject to separate supply and demand forces. While oil prices have risen 80 percent in a year, gas prices climbed only 24 percent.

The higher prices have allowed companies to extract oil from sources too expensive to tap only a few years ago, like the Canadian oil sands and deepwater sites in the Gulf of Mexico, said Gary Adams, who heads the U.S. oil and gas practice for Deloitte & Touche USA LLP. He expects the price of oil to settle at around $90 to $100 a barrel in the coming months.

Even if oil prices fall back to $60 or $70 a barrel, "the capacity of those businesses to do well and fund major projects will continue," said analyst Bernard Picchi of securities firm Wall Street Access. "These are great storehouses of value, and I don't think anyone can take that from them right now."