Free markets are essential and they have many benefits, but they are not perfect. Many economists, including economist Peter Dawson, agree. The global financial crisis, along with those infamous, Frankenstein-like, mortgage-backed securities and the massive, publicly-funded bailouts for failed free market institutions demonstrate this.

Another example, according to Dawson: the free market and oil. The mantra is, it's best to let the market determine the price of oil. Economist Dawson is doubtful, because oil price swings create economic havoc.

Consider the predicament airline, delivery, and related executives who manage businesses that have a major fuel cost face: you know that this year the price of oil is going to be somewhere between . . . $30 and $110. "Now that clarifies things," Dawson laughs. "Piece of cake."

Also, consider what oil industry executives face: try making and managing a 5-year or 10-year exploration budget. What's the price of oil going to be in three years? $20? $50? $75? $150? "Nobody knows, and it's creating havoc in exploration circles," Dawson said.

The oil market breathed a minor sigh of relief Thursday after Saudi Arabia said there would be no replay of 1973-74 regarding the current Middle East crisis.

Saudi Foreign Minister Prince Saud al-Faisal said oil "isn't a weapon" to end the conflict between Hamas and Israel, Bloomberg News reported. Prince al-Faisal said oil can't reverse the conflict, countering a call by OPEC-hawk Iran that Arab states stop producing oil as a way to pressure countries supporting Israel.

Oil continued its recent downward trek Thursday morning on the news, falling $1.58 to $41.05 per barrel. Oil hit an all-time of $147.27 per barrel in the summer of 2008.

In 1973, the Arab members of OPEC implemented an oil embargo against the United States in response to the U.S.'s decision to re-supply Israel's military during the Yom Kippur War, which Israel won. The price of oil subsequently quintupled from about $20 per barrel to about $100 per barrel in 2009 dollars (or from about $3 per barrel to $13 per barrel in 1974 dollars), creating the world's first oil shock, and triggering a U.S. recession.

The other major energy commodities also declined early Thursday. Heating oil fell 2 cents to $1.54 per gallon, unleaded gasoline decreased 3 cents to $1.07 cents per gallon, and natural gas dipped 5 cents to $5.92 per million BTUs.

President-elect Barack Obama and the new U.S. Congress, correctly, have to focus on getting the U.S. economy moving again, but the Democrats can not lose sight of another key policy area in 2009: energy policy.

Simply, the United States must finally end its dependence on foreign oil, and, in time, on oil itself, and the new administration must take giant steps toward this goal beginning in 2009.

Oil shocks devastate U.S. economy

Three oil shocks (1973-74, 1979-80, and 2008) have been major factors in three U.S. recessions, the U.S. transfers $200-$550 billion in wealth overseas annually - - depending on oil's price - - just to pay for oil imports, and imported oil has complicated U.S. foreign policy, to say the least.

Economist Richard Dawson estimates that if what Americans paid for foreign oil were retained in the United States economy, U.S. GDP would increase by 0.3-0.5 percentage points annually, "creating hundreds of thousands of domestic jobs and keeping that wealth and income working where should be working, in local economies."

Economist David H. Wang, who grew up in China but moved permanently to the United States in 1989 for graduate study, is a fan of both traditional Chinese and contemporary American cuisine. And among his favorite American entrees is the classic porterhouse steak dinner.

On Tuesday Wang spent part of the day reading the restaurant reviews of some of New York's world-class steak houses. (We won't list the restaurants' names in this space: they would represent free plugs, and each has a business strong enough to pay for an advertisement.)

Almost reservation time

Wang reviewed the steakhouses' menus because he is likely to win a wager with yours truly, involving the price of oil. I argued that the price of oil would never drop below $40 per barrel again. Wang argued it would, and would also remain below $80. The wager calls for the loser to buy the winner a dinner in every year the price of oil drops below $40 or rises above $80.

Now back in May the wager looked like an 'easy win' for me: oil was sitting pretty, with a price above $110 and arcing ever higher. It looked like economist Wang would be buying dinners for many years in a row.

The fact that gasoline prices have risen, then fallen, is nothing new, so says energy trader Jim Dietz.

Gasoline prices have risen and fallen - - or exhibited cyclicality, in traderspeak - - for decades.

Consider:

• 1973-74 Arab oil embargo: Oil Shock I - - U.S. gasoline prices double from about 35 cents per gallon to about 60 cents per gallon. (Or from $1.50 to $2.50 per gallon in today's dollars.) U.S. recession ensues. Over the next six years prices decline to about $1.80 in today's dollars.

• 1979-80 Iranian Revolution: Oil Shock II - - U.S. gasoline prices double from about 70 cents per gallon to $1.45. (Or from about $2.00 to $3.50 in today's dollars. U.S. recession ensues. Over the next 10 years prices decline to about $1.60 in today's dollars.

What is new about this cycle, Oil Shock III, is the speed of gasoline's price plunge: never have gasoline prices plummeted so much, so quickly, Dietz said.

"After rising to what had been historically high levels of about $2.50 per gallon in 2006, prices rocketed up to ridiculous levels above $4 per gallon this summer in what we now know was a speculative bubble, a lot of it fed by leverage-amplified hedge and investment funds," Dietz said. "They distorted the market, no question."

If economist David H. Wang had predicted earlier this year that oil would fall to $40 per barrel in 2009, "I would have lost my reputation as an economist in standing," he said.

Or, "they would have probably said I was in need of 24-hour observation," he added.

Well, $40-per-barrel oil in 2009 doesn't appear to be that outlandish now. In fact, in the view of one research operation, it looks downright high.

Merrill Lynch said oil may fall below $25 per barrel in 2009 as a global recession takes hold, Bloomberg News reported Thursday, reducing demand for the world's most important commodity.

The dreaded China slowdown

Equally significant, the global recession may further slow China's economy, creating an even larger surplus in key commodities. Further, even though Merrill reiterated its November forecast that oil futures will average $50 per barrel in 2009, Wang said if China's GDP growth, currently in the 6-8% slows to 5% or below, all bets are off regarding commodity prices.

"Today's oil prices assume continued, solid, if not double-digit growth in China," Wang said. "If China's economy slows further, and we start see real year-over-year declines in oil consumption in China, not just cuts in the level of oil consumption growth, oil prices will fall well below $40 and that $25 forecast will come into view."

Oil dipped 44 cents to $46.35 per barrel in Thursday morning trading. Oil has fallen a stunning $100 since hitting a record high of $147.27 per barrel last summer.

History is repeating itself, at least in the oil market.

Once again, a miscalculation by OPEC -- probably motivated by greed or rational self interest carried to its logical (but foolish) extension -- has resulted in almost the same set of market conditions that resulted when OPEC made the same mistake in 1990-1991.

Then, following the Persian Gulf War in 1990, OPEC increased production only grudgingly, in an attempt to hang onto sky-high oil prices of about $55-60 per barrel. (Or about $120 in today's dollars.) The result? A U.S. recession and a consequent collapse in oil demand, and in oil's price: oil first fell below $40, then $30 on its way to trading below $13 per barrel in 1998. Thirteen dollars a barrel in nineteen ninety-eight.

Those who fail to learn from history...

Fast forward to 2007. OPEC has an opportunity to at least slow, if not reverse the steady rise in oil prices, which were then testing $90. However, despite the fact that oil shocks have preceded every U.S. recession since 1972, except the post-September 11, 2001 recession, OPEC does nothing.

In fact, as the price of oil continued to spiral to dizzier and dizzier heights, OPEC meetings served as information dissemination opportunities to blame the rising price on anything but a lack of increased OPEC production: the weak dollar, geopolitical concerns, investors who view oil as a performing asset, and so on. In fact, what OPEC was doing during this phase of the oil cycle was, yet again, testing the limits of the market: i.e., to determine the maximum price the market could bear, in order to maximize revenue for oil-producing nations. Or, in other words, OPEC members were repeating the mistakes of 1990-1991.

There have been almost no bright spots during the U.S. economic downturn -- no investor or typical citizen would trade minor pluses for the credit market and economic conditions the U.S. currently faces -- but at least one area of commerce offers some encouraging news.

The nation's average price for gasoline has dropped below $2 to $1.99 per gallon, according to a survey by motorist group AAA.

Technically, the price dropped 2 cents to $1.989 per gallon, but the macro point is the important fact: gasoline prices have fallen at their fastest rate since 1981-1983, when prices declined after the end of the 1979-80 oil shock caused by the Iranian Revolution, which devastated Iran's oil sector.

During that period, U.S. gasoline prices fell from about $1.50 per gallon to about $1.10, or from about $3.50 per gallon to about $2.40 in current dollars, economist Peter Dawson said.

Hence, the drop in gasoline prices this late summer / fall has been a record-setter in percentage terms. "The price drop has been stunning. We've dropped 50%, from an average price over $4.00 a gallon to under $2.00, and we've done it in less than a year. That's just stunning," Dawson said. "Historically, it's taken a year or longer for prices to retreat after an oil shock, and in the case of the 1979-1980 oil shock, several years."

There's modest good news on the gasoline front for U.S. consumers, but don't write (or e-mail or text message) home just yet.

Several key oil-producing nations are preparing for the prospect of $45 per barrel oil, indicating these oil exporters believe the price of the world's most important commodity is likely to fall more amid both U.S. and global economic recessions.

Saudis prep for oil's slide

Saudi Arabia, which possesses the largest proved oil reserves in the world, has passed a government budget that's prepared for $45 oil, stratfor.com reports. Meanwhile, Nigeria and Libya have reduced their 2009 oil price forecasts to $45.

Oil, which has plummeted more than 60% since hitting a record high of $147.27 this summer, fell another 48 cents to $58.85 per barrel in Wednesday morning trading.

Economist Richard Felson said the oil price plunge and the gasoline price drop it has created is good news for U.S. motorists, with certain qualifiers. "It is an astounding drop, approaching a $100 per barrel drop, and that has taken pressure off refined energy products," Felson said. "The problem is, if analysts are correct about $40-45 per barrel oil, it implies a slowdown in U.S. and global GDP that will likely mean large layoffs, which isn't good for anyone."

It's a pattern that's been all too familiar in the oil market these past few months: the price of oil moves slightly higher, but then can't sustain its increase and the rally fails, usually with oil closing lower at the end of the day.

What's causing it? Energy traders and economists will tell you that the price decline is being driven by slowing oil demand growth in emerging markets, combined with real, year-over-year demand reduction in the world's biggest market, the United States.

Investors exit oil

But that's not the whole story behind oil's stunning drop from $147 to the $60-per-barrel-range, so says Energy Trader Jim Dietz. Dietz who argues that the global reduction in the availability of leverage -- money borrowed for use in trading -- has taken a considerable amount of the buying pressure out of oil, as well as other commodities.

"We clearly are not seeing as many hedge funds and investment funds establishing positions in oil, and the ones who are in the market are establishing smaller positions," Dietz said. "As a result we rarely see any more powerful moves to the upside with powerful momentum characteristics. I'm not saying hedge fund buying is the only reason oil hit $147 this summer, but they certainly played an important role."

What better evidence does the United States need to increase fleet-wide auto efficiency and pursue conservation measures than another production cut by OPEC?

Iran Monday said OPEC may meet before its scheduled meeting on December 17 to discuss production if oil prices keep falling, Bloomberg News reported.

Oil rose 94 cents to $61.98 per barrel on Monday at mid-day after China announced that it will spend an additional $586 billion in fiscal stimulus to maintain economic growth, amid a global economic slowdown, the Agence France Presse reported Monday. (Most economists/analysts view signs of continued, adequate GDP growth n China as bullish for oil prices, given the size of China's economy.)

OPEC concerned about falling prices

Gholamhossein Nozari, Iran's oil minister, said an OPEC meeting this month "is possible," if oil's downward trend continues, Bloomberg News reported. Oil prices have fallen more than 55% in 2008 since hitting a record high of $147.27 per barrel in July.

Earlier this month, OPEC, which accounts for about 40% of the world's oil production, announced a production cut of 1.5 million barrels per day, effective December 1.

Economist Peter Dawson did not fill up his car's gas tank with gas Saturday, and for a good reason.

"The price of gasoline is trending lower, so the longer you wait the less you'll pay," Dawson said.

In fact, in addition to cutting back his driving, Dawson is performing another modest act of conservation, which, if applied across the states, should help lower prices even more over time: he's not filling up his tank. If he uses 10 gallons in a week, he's replacing the 10, not filling the tank completely.

The above will help cancel-out the effect of a practice that's all-to-familiar to drivers: as soon as oil prices rise, gasoline stations immediately increase their prices. During the current oil shock, gas stations would some times raise prices 20 or 30 cents overnight, occasionally, more, he said.

The above practice is justified from a cash-flow standpoint, Dawson said, because gas stations are trying to prepare for the higher cost of the next gasoline delivery from gasoline wholesalers: a rise in oil prices means their next delivery is going to cost more, and to pay for it, gas stations "immediately raise their prices, so their cash flow isn't hurt."

What a difference a year makes.

A year ago, October 2007, oil vaulted above $85 per barrel on its way to the unheard-of (at that time) price of $100 per barrel. Oil would reach a high of $147.90 per barrel in July.

Along the way several research reports predicted a $175-$200 price for oil in the near future. The weak dollar played a role in the astronomical price rise of the world's most important commodity, as did speculative and momentum players (hedge funds, investment funds), but the real culprit was rising emerging market oil demand.

Another October Surprise (of sorts)

Fast-forward to this October: emerging markets are still growing, but every other factor is now bearish for oil, says energy trader Jim Dietz, and oil's price is in free fall, plunging another $3.99 to $67.55 per barrel Wednesday morning. The United States economy is in recession -- not officially, but nearly every key indicator is. The U.K. and E.U. economies are slowing. Moreover, the financial crisis threatens to slow the growth in global trade, if not lead to outright trade volume declines, implying further declines in projected oil demand. "It's a market that's pricing in substantially slower global economic growth, possibly a global recession," Dietz said. He added that he was currently short oil, with a monthly contract.

Moreover, those searching for an oil bottom may be hard pressed, Dietz said. "There's considerable technical support for oil in the $63-67 range and then again at $60, but these barriers have not provided much support in this market," he said. "That leads me to believe that the unwinding [closing] of hedge fund positions is a big factor in driving oil lower. They're getting out of crude, big time."

Oil prices, the source of so much inflation and consternation in the developed and developing world, are expected to continue to slide toward $60, economists and traders say, even as OPEC prepares to cut production at a special meeting this week.

Oil has fallen about 50% since hitting a record high of $147.27 per barrel in July, amid a financial crisis that's slowed growth in every region of the globe. Further, OPEC, which produces about 40% of the world and will hold a special meeting October 24, will only able to slow oil's descent to the $60-range, with anticipated production cuts, so says economist Peter Dawson.

"The report that China's economy grew at a 9% annual rate in the third quarter is the last piece of the oil demand puzzle, as far as the slowdown is concerned," Dawson said. "China was growing at better than 10% in the same quarter a year ago, so that will further reduce the growth in global oil demand, which is bearish for oil prices. Prices will most likely slide toward the $60-range by mid-2009." Oil rose $1.35 to $73.20 per barrel in Monday morning trading.

OPEC again cut its forecast for 2009 global oil demand, the cartel announced Wednesday in its monthly report, raising the specter that hawkish cartel members will push for production cuts at a special meeting next month.

OPEC now believes (pdf) that 2009 global oil demand will increase by 800,000 barrels per day to 87.21 million barrels, compared to the previous forecast of a 900,000 barrel per day rise.

OPEC said its production in September averaged 32.16 million barrels per day, down about 310,000 from August.

Energy prices continue to fall

Energy prices retreated Wednesday on the news. Oil fell $3.44 to $75.21 per barrel. The other major energy commodities also fell in early trading Wednesday, continuing their nearly month-long downtrend. Heating oil fell about 5 cents to $2.20 per gallon, unleaded gasoline declined about 8 cents to $1.80 per gallon, and natural gas fell 7 cents to $6.66 per million BTUs.

In its report, OPEC said that even if governments are successful in unfreezing credit markets, the fallout in the real economy is expected to be considerable. The credit drag, combined with decelerating growth in both developed and developing world economies, will weigh on oil demand throughout 2009. OPEC has called a special meeting for November 18 to address what it argues is an oversupplied global oil market.