What's Behind (and Ahead for) the Plunging Price of Oil

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Paul Sancya / AP

Gopesh Patel fills his SUV with gas in Troy, Mich., on Oct. 10

It doesn't feel like it, but we got a raise this week. The plunging price of oil, which prompted OPEC to announce a 1.5 million barrel a day production cut, has put money in the pockets of recession-worried consumers. "It follows that there's going to be some spending effect," said Francisco Blach head of commodities research at Merrill Lynch in London.

Oil demand in the U.S. has dropped 10% in the few weeks, continuing a year long trend. According to the U.S. Department of Transportation, Americans drove 15 billion fewer miles in August, or 5.6% less than they did the year before. DOT says it's the largest ever year-to-year decline recorded in a single month. Over the past 10 months, Americans have driven 78 billion fewer miles than they did in the same 10 months the previous year — sure proof of what economists call "demand destruction."

Coping with $4 a gallon gasoline has drastically altered driving patterns, perhaps permanently. "We are seeing changes in habits," says Julian Lee, senior energy analyst with the Center for Global Energy Studies in London. "The sales of big gas-guzzling vehicles have collapsed. If we see that kind of change it becomes a much longer term issue with long-term demand destruction." In the short term, there's simple math. The average driver goes about 12,000 miles a year at 20 miles per gallon, says Ken Medlock, an Energy Fellow at the Baker Institute at Rice University in Houston, Texas. If gasoline drops $1.50 the $900 that Joe Average Driver saves would amount to a big stimulus package. According to Ed Leamer, director of the UCLA's Anderson Forecast, the current price slide could drop another $200-to-$250 billion into consumers' pockets, given that as of the second quarter personal spending for gas fuel oil and other energy was about $442 billion on an annualized basis. By way of comparison, Wal-Mart's U.S. stores took in $240 billion in the last fiscal year. "For consumers, it's welcome relief," says Medlock. And because the U.S. is out of its peak summer driving season, there's not too much of an incentive to drive a lot more just because gas prices are down.

Falling worldwide demand, especially in emerging markets, is the reason that the oil market made road kill of OPEC's production cut. Oil dropped yet again to $64 a barrel — its lowest level in more than a year. For months leaders of oil-rich countries have watched nervously as world oil prices have tumbled more than 50% from the all-time high in July of $147 a barrel.

All of which spells crisis for OPEC. Since last month oil ministers in Iran and Venezuela — both of which are heavily dependent on oil revenues — have pushed fellow OPEC members to make big enough cuts in production to reverse the plunge in prices; both argued for a cut of two million barrels when they arrived in Vienna on Thursday for OPEC's emergency meeting. OPEC countries set oil production quotas, and their tactic of fixing their combined output has for years hugely influenced world prices, since OPEC's 13 members account for about one-third of the world's total oil supplies.

(Click here for a Gallery of 10 Things to Like About $4 Gas.)

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