With the latest credit market jolts leading to Lehman Brothers Holdings Inc. (NYSE: LEH) decision to file for bankruptcy and the Bank of America Corporation's (NYSE: BAC) move to acquire Merrill Lynch & Co., Inc. (NYSE: MER), it may seem like a misapplication of analysis to discuss oil.

Not so, says one energy trader. "Oil can be a factor in righting the markets and the U.S. economy," Energy Trader Jim Dietz told BloggingStocks Monday afternoon.

How so? "A substantially lower oil price will increase disposable income, help put a lid on rising business costs for transportation and heating, and lower the U.S. trade deficit. These are all good things, shots in the arm for the U.S. economy," Dietz said. "And right now we'll take any shot in the arm we can get." Dietz added that he was currently short oil, with a monthly contract.

Oil Monday afternoon was down $4.25 to $96.93 per barrel, continuing a two-month trend of lower oil prices. Oil hit a record high of $147.27 per barrel in July 12.

Upset about paying $3.80 a gallon for gasoline? Hank Paulson, former Goldman Sachs Group (NYSE: GS) CEO, argued that it was all supply and demand so quit your bellyaching. I thought speculation was playing a big part -- traders who bought oil and sold the dollar to drive up the price. Indeed, a few months agao I found a source who thinks 60% of the volume was from speculators.

Seems even that was too low an estimate. The Washington Post reported Wednesday that the Commodities Futures Trading Commission (CFTC) has analyzed the books of oil traders and calculated that 81% of oil trading volume was conducted by speculators.

Guess who broke open the opportunity for oil speculators to trade oil in a loosely regulated fashion? Goldman. The Post reports that In 1991, its J. Aron unit argued that "it should be granted the same exemption given to commercial traders because its business of buying commodities on behalf of investors was similar to the middlemen who broker commodity transactions for commercial firms."

These are tough economic times for the nation, most would agree, and one hard-hit sector has been the airline sector, specifically the major carriers.

Surging fuel costs, the increased precautions and reviews required for the post-September 11 era, and intensifying competition for international routes has led to large losses among many major carriers - - a condition that has forced them to raise fares and implement other cost-cutting changes.

Most have also instituted a baggage fee for a passenger's second bag, with some carriers charging for all bags. Still, for the most part travelers have taken the baggage fees in stride. Although viewed as a nuisance by many travelers, the reality is a second bag, in particular, is optional weight that increases flying costs per mile. And with aviation fuel zooming past latte-price levels, that's no significant expense.

Still, US Airways Inc. may have gone one too far with the fee system. Effective today, US Airways will start charging for water on flights by coach passengers, The Wall Street Journal reported Friday (subscription required). Bottled water will be $2. Passengers flying first class are exempt from the extra fee.

Billionaire oilman T. Boone Pickens has launched a new campaign to substitute at least a portion of the U.S. imported oil with domestic natural gas.

Pickens would like renewable energy sources, wind power chief among them, to run electric power generation plants currently run by natural gas/coal, and use that natural gas to fuel natural gas vehicles.

Economist Glen Langan told BloggingStocks Thursday the PickensPlan is commendable for a number of reasons (it would lower the trade deficit, create domestic jobs, and decrease greenhouse gas emissions), but investors and readers should not view it as a panacea for the nation's transportation energy bill. "It could be a part of the solution, but it won't address the entire imported oil problem," Langan said.

Another oil saver: better engines

What's another key to reducing both imported oil and U.S.-produced oil consumption? Something that the U.S. auto sector has under-emphasized for more than a decade: technology-driven increases in car/vehicle efficiency, Langan said.

Langan said vehicle weight reduction, transmission/drive train improvements, enhanced aerodynamics, and the biggest factor -- increased engine efficiency -- "have the potential to reduce oil imports by almost as much as the Pickens Plan, and the changes won't take 10 years to see the results."

Further, many of the mpg-enchancing technologies already exist, Langan notes; he suggested an additional federal tax credit for automakers to help them incorporate the changes sooner.

"The fleet [all vehicles driven in the U.S.] should average 25-27 miles per gallon right now. Currently we're at about 20 miles per gallon. With appropriate federal tax credits we could be at 30-32 miles per gallon in five or seven years," Langan said.

U.S. producer prices soared a seasonally-adjusted 1.8% in June, the U.S Labor Department announced Tuesday, as rising energy prices continued to increase wholesale costs at an alarming rate.

Economists surveyed by Bloomberg News had expected the June PPI index to rise 1.4%. Producer prices increased 1.4% in May and 0.2% in April.

The core rate, which excludes food and energy costs, increased 0.2%, the Labor Department said, below the Bloomberg News 0.3% consensus estimate.

Economist Peter Dawson told BloggingStocks Tuesday the June PPI is another unfortunate data point for the economy, but it's not as bad as it appears. "The report is bad, but not as bad as it could have been. Energy really drove the index higher. If you took out gasoline prices, PPI would be down a half percentage point," Dawson said. "That said, energy prices are still rising at an alarming rate and they're a cost concern for businesses and individuals alike."

OPEC President Chakib Khelil Monday blamed the U.S. Federal Reserve for sky-high oil prices, The Associated Press reported, adding that surging prices are not likely to decline.

Khelil said he believes the declining dollar has pushed oil higher and that the Fed's interest rate reductions to boost the U.S. economy are the primary reason for the dollar's decline, the AP reported Monday.

In an effort to jump-start the U.S. economy slowed by the nation's worst housing slump in a generation, the Fed has cut short-term interest rates by 325 basis points to 2% since September 2007.

Khelil's comments did not push oil higher as of early Monday afternoon. Oil traders looked past those comments and focused on the dollar's rise for the day versus the euro and pound, and new data points suggesting a deeper, longer U.S. recession, energy trader Jim Dietz told BloggingStocks Monday. Oil fell $3.70 to $141.59 per barrel, with futures hitting a daily low of $140.15 earlier in the day.

Oil traders adopt 'defensive' stance

"Right now the oil market is focused on the U.S. economy not OPEC's comments, and many were spooked by the Freddie Mac and Fannie Mae announcement. Everything is in pullback mode now, oil, stocks, gold, other commodities. The mood is defensive...preserve capital, basically," Dietz said.

Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) may have to raise up to $46 billion and $29 billion in capital, according to Lehman Brothers (NYSE: LEH), Bloomberg News reported Monday. Fannie Mae fell $3.17 to $15.61 while Freddie Mac declined $2.51 to $11.99 in Monday afternoon trading.

Oil's record price rise in 2007-2008 rivals price increases during the two previous oil shocks, in 1973-74 and 1979-80.

Moreover, while we'll leave for sector analysts and economists to declare if oil's 100% gain in 2008 and 400% gain since 2000 qualifies for an oil shock, those analysts and economists generally agree that the price rise has been driven by rising demand, particularly increased demand for oil in emerging markets, such as China and India.

However, that's not to say that the weak dollar and speculators / institutional investors have not affected the price of oil to the upside: they have, economists generally agree. Further, most analysts also believe oil's price contains a 'geopolitical / civil unrest risk' premium, as well. But all of the aforementioned does not blot-out the primary driver: the fact that about 1 billion new consumers of oil in emerging markets (in the form of car owners, factories, and commercial trucks) are being incorporated into the industrialized world, as the initial decade of globalization progresses.

Given the demand characteristics, and ignoring. for the moment, conservation / efficiency issues and alternative energy sources, a natural question concerns supply. Are there any nations that could increase supply by large amounts? Indeed there are three, but the answer is not as simple as 1-2-3.

The 3 major oil reserve nations

• Iraq – The possessor of the third largest proved reserves (115 billion barrels), Iraq's oil production has been depressed by the Iraq War, and delays in massive required repairs to its infrastructure. By extension, a sustained increase in production assumes a cessation of hostilities and a political solution, and these are not on the immediate horizon. But the point here is that Iraq is capable of producing 6, 7, even 8 million barrels of oil per day, given investment and a stable government. Iraq's current output is about 2.5 million barrels per day, according to the Middle East Economic Survey.

The Department of Energy announced it was throwing some money at the electric car dream yesterday. They'll spend "up to $30 million in funding over three years" on three projects they hope will produce a viable electric car by 2014. Wow, that's a whole $10 million a year!

The DOE is funding three projects they hope will produce an electric car that can go 40 miles on a charge, enough for 70% of daily commuters. They made the announcement at a conference on Plug-in Electric Vehicles 2008: What Role for Washington? Apparently the Energy Department decided the role was to make a token amount of funding and let other countries take the lead. The plan is to split the cost 50-50 with industry. General Motors (NYSE:GM) is going to work on a Lithium-Ion battery. Ford (NYSE:F) will work on a way to speed up mass production of electric cars. And General Electric (NYSE:GE) will try to figure out a two-battery, 40-mile system.

I'm sure everyone's working on all sorts of other projects, but this one just seems tiny, especially in context of the current oil crisis and the $40.1 billion requested Department of Transportation budget for FY2009. As cNet's Elsa Wenzel helpfully points out, Toyota (NYSE:TM), working with Matsushita Electric Industrial (NYSE:MC), thinks it can mass market an electric car by 2010.