A Steep Drop in Oil Prices to Come?

Some pretty smart people are looking for oil prices to drop significantly.

Oil's jump makes history, but true test is yet to come.

The future of global oil demand is more uncertain than ever given the U.S. rescue plan for the financial market, and no one's sure about the impact and recovery pace of production and refinery activity in the Gulf of Mexico following the recent hurricanes, analysts said.

On Monday, a steep drop in the U.S. dollar, assumptions that the government rescue plan will help improve the economy and boost oil demand as well as short-covering related to the expiration of the October crude contract on Nymex all combined to pull oil prices to their highest intraday level in two months.

So, oil jumped today because of the dollar dropping in value and the anticipation of the government bailout working and economic growth taking off. So now what?

"But some of what's going on really doesn't make any sense. A worrisome economy and financial market should translate into lower demand for oil, some analysts said.

"The oil market is caught up in the same hysteria of the rest of the financial markets," said Anthony Sabino, a professor of law at St. John's University, whose legal practice includes oil and gas law.

"We can and will get through this" as the markets did back during the Great Depression in the 1930s, he said. "So oil traders getting caught up in the general panic is just plain dumb. If the economy is so bad and uncertain and panicky, [the] price per barrel should be deflating like crazy because demand is cratering," Sabino said.

The same insane speculation that drove investors into "toxic investments" such as subprime lending and collateralized debt obligation has infected the oil market, "so for no good reason at all they are driving oil up to unsustainable prices," he said.

It's a "wholly illogical disconnect," Sabino said. With the U.S. stock market down by so much and money tight, logic says oil demand will "continue to drop like a stone, so prices should be back at $90 and heading south to $80."

What you have is money running around the market like a rat in a maze, looking for a safe haven and some positive yield on the investment. But every move made to reinvest in something else creates more disconnect between actual supportable price and what the market price is. Of course, that Congress playing games for election purposes does not help at all.

I'm looking for things to be volatile until the election and then settle down. After that, I think oil may drop to the $80-$90 range.