But the supply picture could deteriorate in the months ahead. Not only could non-OPEC production fall another 350,000 or so like in 2008, especially as US production is almost 2% below year-ago levels even though the EIA predicts 6+% increase in 2009 (current lower production is probably a result of the oil rig count falling due to more expensive old wells losing their profitability on the low prices). On top of those natural declines, OPEC may decide to pull their production back further and foster 2007 prices again (~$70-$75 per barrel) by the end of the year. This could happen even if global demand falls because Saudi Arabia has shown in the past that they are good at limbo when they decide to be (they lowered their production from over 10 million barrels per day (b/d) to less than 5 million b/d in the 1980s). Saudi Arabia recently announced a further decrease in production for February to 7.7 million b/d, a level 2 million b/d below last summer’s production crest. This decrease is designed to put a floor on oil prices and potentially help them increase above $40. There may be more supply reductions in the months ahead to help prices move toward $70.

An economically rational Saudi Arabia would lower production if they felt that would raise prices. For example, selling 6 million b/d for $70 earns the country almost 50% more revenue than selling 8 million b/d for $36. Of course, they would love to have the solidarity of fellow OPEC producers in such a reduction of supply. But as the largest world producer and exporter, Saudi Arabia has the greatest ability to swing its production to achieve a higher or lower price.

And OPEC’s reluctance to increase production in early 2008 to lower oil prices shows that if they attain market control from a falling non-OPEC supply, they may allow oil prices to move beyond $100 again in 2010 if demand recovers by then.

Bottom line: Oil prices are close to their historical average, but have upside risks due to the natural decline of non-OPEC fields and the decision of OPEC producers to maximize their revenue. Even while the recession keeps demand low worldwide, it would be prudent for all of us importers to plan for $2.50+ per gallon gasoline in the medium term and even higher prices in the long-term so that price shocks do not derail our economic progress. The best route to achieve this is through a sustainable energy transition based on efficiency and continued growth in renewable energy deployment.