Why gasoline prices could ease soon

Demand for oil has dropped, sending its price lower. Another factor: an expected slowing in the economy.

For Americans tired of watching prices rise at the gasoline pump, relief may be on the way.

After the price of oil hit a high of $75.17 a barrel last month, demand in the United States dipped a few percentage points. Demand by other big developed economies has also eased in recent months, reaching a level that's actually lower than a year ago.

Oil markets started to factor in some of these supply-and-demand dynamics last week: The price of crude oil fell below $70 a barrel on Thursday. (By Friday, however, it had inched back above $71 a barrel, following news about Iran and a tropical depression headed toward the Gulf of Mexico.)

Still, the lower prices are a good sign for consumers - and the price of the hydrocarbon could stabilize or drop more if, as widely expected, both the US and global economies grow at a slower pace for the rest of the year.

"Demand is falling ... because of a response to higher prices," says economist Mark Zandi of Moody's Economy.com. "Layer on weaker economic growth, and you will see a measurable decline. Ultimately, prices will moderate."

The trend could have broader ramifications, too. If the easing were to continue, economists say it could help provide a cushion that might smooth out potential supply disruptions, such as from civil unrest in an oil-producing area. Lower or stable oil prices might also relieve policymakers at the Federal Reserve who are worried about the inflation rate. And eased prices might give lawmakers some respite this fall when they face voters.

But some experts caution it's far from certain that oil prices will stay lower. "The next headline gets us to $80 a barrel: There is not going to be an epiphany of reasonableness anytime soon," says Mike Fitzpatrick, an oil trader at FIMAT USA. "I'm not saying prices won't fall because of economic contraction, but it's still too early to say the signs are showing that."

The last time oil consumption fell was the recession that started in 2001. Oil prices were in the $20- to $25-a-barrel range, and gasoline cost about $1.40 a gallon. "No one is saying oil is going back to $20 a barrel, but the debate is whether it goes down to $60 a barrel or up to $80," says Mr. Zandi. "I see it going to $60 because demand growth is slowing."

A poor economy can affect gasoline sales as disposable income shrinks, notes energy analyst Mark Routt of Energy Security Analysis Inc. in Wakefield, Mass. But, Mr. Routt adds, only a small portion of gasoline sales responds to price. "The price of gasoline is up 40 percent over last year, which is up 40 percent over the year before. Yet gasoline consumption still grew," he says.

The steady rise of gasoline prices, combined with increased food costs, higher interest rates, and a slowing of the housing market, are already stretching consumer budgets, argues Ken Goldstein, an economist at the Conference Board, a business research group in New York. He expects consumer spending to drop from a 4 to 5 percent growth rate last year to about 2 to 3 percent in the second half of this year and into 2007. "If consumers are spending at 3 percent or less this year, it provides less of a cushion for the economy if another hurricane hits," he says.

Sunday, tropical storm Alberto became the first named storm of the 2006 Atlantic hurricane season. "It's early in the season, but this storm will get a lot of attention following two very active hurricane seasons," says Paul Walsh, a senior business meteorologist at Planalytics in Wayne, Pa. "We expect a stronger-than-normal consumer reaction."

The storm comes at a time when most refineries in the Gulf of Mexico have restarted since Katrina, although they're not at a full level of operation, says John Felmy, chief economist at the American Petroleum Institute in Washington.

Since hurricane Katrina, he notes that overall energy demand in the US has been negative for almost six of the past 10 months. "There has been a weakening of total demand, not just gasoline," he says.

If energy prices drop because of falling demand, this could help take some of the pressure off the Federal Reserve, says Dennis Jacobe, chief economist at the Gallup Organization. "If gas prices eased, it would give the Fed the option of pausing [in raising interest rates]," he says.

However, he also says the Fed likes to look at the core rate of inflation. That rate is now rising at over a 2 percent rate - above the Fed's target. Economists will get another look at inflation this Wednesday when the May consumer price index is reported.

Congress would also be happy to see energy prices stabilize or drop before the fall elections. "Lower gas prices are better for incumbents," says Mr. Jacobe.

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