No doubt this next discussion will cause readers to do a double-take over their morning cup of coffee. But comments and brickbats welcome.

Here's the eye-opener: OPEC may do the U.S. and other nations a favor, long-term, by cutting production.

How's that again? A favor by cutting production?

Indeed long term that would be the case, with the emphasis being on long term.

Here's the low-down: The market is awash with oil. Inventories are building both in the U.S. and abroad, due to decreased demand stemming from the U.S. and global recessions.

What's more, in the U.S. there appears to have been a structural change in gasoline consumption: motorists, stung by high gasoline prices twice in the past 4 years -- including to more than $4 per gallon gas last summer -- are now convinced that relatively low gas prices today will only be temporary, and they're opting for more-efficient vehicles. That will limit increases in gasoline consumption in the U.S. when the economic recovery starts.

Combine the above with only modest oil consumption increases in emerging markets and one can see why oil has plunged about $100 in less than a year. And the price drop has occurred despite a production reduction of 4.5 million barrels per day (bpd) by OPEC. Oil traded Wednesday up 23 cents to $40.19 per barrel.

A too-low oil price?

The problem is, however, if the U.S. recovery does not start in Q3/Q4, oil prices will continue to decline without another substantial OPEC production cut, to prices well below levels most oil analysts say is conducive to oil exploration and development. Essentially, if oil drops to $25 or even $20, integrated oil companies and others will take higher-cost production areas out of service and will reduce exploration and development projects. And that reduced exploration and exploration will set the stage for the next spike in prices.

In other words, it's in nobody's interest to see the price of oil collapse. Super-low oil prices may seem nice to consumers for awhile, but they create market havoc almost as bad as bubble prices. Super-low prices also discourage the development of renewable/alternate energy sources.

Hence, the ideal is to have a price that's not too high for the global economy to grow at an adequate rate, but not so low that it discourages exploration, which is why OPEC can do the world a favor, long term, by cutting production. OPEC meets next in March in Vienna and analysts are looking for a 1.0-1.5 million bpd cut to stabilize oil prices in the $40-45 range for the rest of 2009.

Oil/Economic Analysis: U.S. drivers may be aghast at the idea of "rooting for OPEC to take supply off the market" and no one's arguing that anyone needs to hold a pep rally. Still, an oil price collapse below $30 will reduce exploration and create extreme economic stress in oil producing states (Middle East, Russia, Venezuela, among others). Conversely, oil prices stabilized in the $40-45 range will keep the average U.S. gasoline price at $2.00-$2.50 -- not low, but not ridiculously high. For investors, integrated oil companies will look attractive, if OPEC cuts production, as expected, in March.

Bottom Line: OPEC's supply cuts should be able to stabilize prices in the $35-$45 range in 2009, with oil's price rising to about $55-60 as the U.S. and global economies recover.


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