What is the oil price outlook for 2005?

Oil prices have come off their autumnal peaks and plunged from $55 a barrel back to the low $40s level. At its December meeting Opec lopped one million barrels per day off its quotas. Now we hear that Singapore is awash with crude oil and that US fuel oil stocks are much higher than anyone thought.

Certainly the fact that Opec members are pulling supply and stocks are high does not seem to suggest that oil prices will move much higher into the start of 2005. Quite the contrary, falling oil prices look on the cards unless the US experiences a particularly polar winter.

From an oil market perspective, we can see that speculation ramped up the oil price in October-November leading to over supply in an effort to calm the market. The problem is that all that oil now has to find a buyer. More supply than demand equals falling prices.

The rattling of sabers by Osama bin Laden and Saudi dissidents last week was a reminder that forces do exist that could push oil to much higher prices.

Yet as both calls to arms were almost completely ineffectual, certainly in terms of doing much to damage the oil infrastructure of the Gulf, then perhaps the 'terror premium' on crude oil will also begin to decline in the New Year.

There are also geo-political forces at work in 2005 that we did not have in 2004. The elections in Iraq at the end of January should bring to power a new independent government, the first since the US-led invasion of March 2003.

At the same time the Palestinian authority will elect a new leader to replace the late Yasser Arafat, and with international support there is a chance for the creation of an independent state of Palestine within a few years. Now if both Iraq and Palestine could be pacified then the 'terror premium' on oil prices would evaporate.

In predicting prices economists often tend to take a ruler and project a straight line upwards. But this brief review of the outlook for the factors behind recent high oil prices - pretty much the whole post-9/11 geo-political scene - suggests that nothing is forever and that the recent boom in oil prices may soon recede.

Of course, the Middle East could yet produce an incident that would spark a sudden spike in oil prices. Nobody expected 9/11.

But when Boeing Chief Executive Officer Harry Stonecipher was in Dubai earlier this autumn he said oil prices were peaking due to an extraordinary number of negatives, and that the outlook was for lower prices. He could just be proved right in 2005.