Oil Down - Dollar Up

We go to New Zealand for the news.

NEW YORK - Oil prices tumbled more than $US3 a barrel overnight as tropical storm Dolly grew increasingly unlikely to threaten supply, giving traders one less reason to buy as a strengthening dollar helped keep prices in check.

The sell-off was a throwback to last week's sharp declines, and dragged crude to its lowest level since early June. It was oil's fifth decline in the last sixth sessions.

So let us look at economics and expectations. If oil prices are rising producers hold off on selling in the hopes of higher prices. This causes oil to rise more. Once the price breaks the opposite starts happening. With prices expected to fall producers want to sell all they can while the getting is good.

So what has changed? Oil consumption and a stronger dollar.

Oil prices came under added pressure from a stronger dollar. The currency rose sharply against the euro after Charles Plosser, president of the Federal Reserve Bank of Philadelphia and a voting member of the Fed's Open Market Committee, said the central bank will probably need to boost interest rates "sooner rather than later."

The dollar's decline has been a major factor in oil's ascent, as investors bought dollar-denominated crude contracts as a hedge against inflation and a weakening greenback. When the dollar strengthens, such currency-related buying often unwinds.

Meanwhile, there were new indications that high oil prices are killing off demand, especially in the U.S., the world's largest oil consumer.

In its weekly pump spending survey, MasterCard found US petrol demand dropped last week for the thirteenth week in a row. Demand fell 3.3 per cent compared with the same week a year earlier, according to the survey. Since the start of 2008, petrol demand is down 2.2 per cent.

That is pretty amazing. A 3.3% year over year drop in US demand. With the US consuming about 25% of the world's oil that is a pretty significant drop. Almost 1% of world demand and we reduced all by ourselves. With no help from our betters in Congress. And that does not even count the moderating or reduction in demand in other parts of the world caused by high prices.

It may be that we have hit the peak in prices for a few years. Because of the long lags in oil production from the time of rising prices until new supplies come on the market, oil prices are oscillatory. If you have an understanding of control theory this is exactly what you would expect. High gains and long lags cause oscillations in any system.

So what might we look forward to? Certainly $3 a gallon for gasoline in another year is not out of the question and $2 a gallon two or three years down the road is a definite possibility. My advice? Buy a used SUV while they are a glut on the market.

H/T Instapundit.