Where Are Oil Prices Headed?

We have been ruminating at Edmunds.com about oil prices. Since March of this year, the sales share of hybrids has been dropping even as fuel prices have remained high. Yet we have been tracking a growing shift back toward larger vehicles. This is interesting, as logic would suggest that if fuel prices are holding at high levels, sales patterns should be stable as well.

Our working hypothesis is that the driver of this seemingly anomalous behavior is shifts in media attention. Media coverage of high oil prices peaked in the spring and has dropped each month since. Buying patterns neatly correlate with this drop. Perhaps it is the attention given to higher prices that triggers the change in behavior, not the prices themselves. (Although I admit it is hard to separate the two.)

We have noted this "attention" effect in other areas as well. Often it is the story, not the facts, that influences behavior. When the facts and the story don't align, the story (or lack of a story) wins. For example, last May, the story was that Japanese-sourced vehicles were high priced and in short supply because of quake triggered supply disruptions. Consumers bought the story and shifted purchases to Fords, Chevys, etc. So for a while the reality was that the supply of Toyota Corollas was actually better than that of Chevrolet Cruzes and Ford Focuses, for example

Understanding how the story can change behavior is useful, particularly as it helps in anticipating the future.

This brings me back to our ruminations on fuel prices. Current retail prices are stubbornly high, and most seem to expect that future prices will be higher still.

But here's the twist: As I said, the consensus belief (or story) on future oil prices is that they will be higher. And short term, this may be the case if and/or when the global economy recovers and/or demand grows in emerging markets.

But there is a longer-term story as well. This story suggests that peak oil may be nigh and the future holds shortages and sharply higher prices. Buying into this story, companies, acting individually, will see profit in expanding exploration, developing sophisticated new extraction technologies, etc.

The aggregate result of all these individual activities is that the future supply of oil will improve and prices will actually drop.

In fact, we have seen this paradox play out before. Through the Seventies, we were first shocked by rapid price increases and then conditioned to believe they would continue. And, of course, oil prices collapsed in the Eighties.

I recently ran across a comprehensive article in The New York Times business section entitled New Technologies Redraw the World's Energy Picture. It is a lengthy piece, but even a brief review shows the same process could well be playing out today -- this time with the aid of advanced technologies. It seems there is a lot more oil out there than we thought.

On the positive side of the ledger, the trend in the United States turning away from Middle East-sourced oil will continue (Did you know Canada is already our largest importer of oil?). Cheap oil should also be a simple boost for global economies. But what about "green" energy sources that need higher oil prices to be commercially viable? Will more Solyndra-like bankruptcies be in the offing? What about the environment? And does it make sense in a global economy to encumber US industry with regulatory-driven higher energy costs than are borne by our less finicky competitors?

Thorny questions indeed.

Closer to home, how will car companies convince consumers to pay more for the new Corporate After Fuel Economy (CAFE)-mandated smaller, lighter, higher-mileage vehicles when fuel prices are low?

In many respects the best "story" today would be that oil prices mid-decade would assuredly be low. This would discourage exploration and the development of new technologies. Mid-term prices would then reliably be higher.

Barring this, we should start thinking now about the implications of the next global collapse in oil prices.

Jeremy Anwyl: Vice Chairman of Edmunds.com. Follow @JeremyAnwyl on Twitter.