The price spikes that drove crude oil over $42 a barrel at the start of June are over, thanks to growing crude oil supplies, fragile but adequate security for critical parts of the Persian Gulf oil infrastructure and now the installation of

a new Iraqi government two days ahead of schedule .

Economists see a generally less-volatile outlook for oil in the second half of the year, noting that the wild swings of the last two months were neither as severe nor as long-lasting as their predecessors of the 1970s and the early 1990s. Those price increases ushered in periods of recession, decreased consumer spending and periods of monetary tightening by the

Federal Reserve

.

Although higher energy prices will be part of the picture for some time, experts say the economy and the oil market have both dodged body blows, though people will continue to pay more to drive their cars and heat and cool their homes than they did last year.

"I think the rise in energy prices that we have seen has peaked, and they haven't lasted long enough to have a significant impact on the overall economy," says Vincent Malanga, president of LaSalle Economics.

In inflation-adjusted terms, oil would have to be around $56 a barrel to replicate the same conditions of the last major price hikes of 1990 and 1991 following Iraq's invasion of Kuwait, says Robert Brusca, chief economist at Fact and Opinion Research.

That's a far cry from current levels, especially after

the decline in crude futures that greeted Monday morning's news of an early transfer of sovereignty in Iraq. Helped by an end to Norway's oil strike, July crude was recently fetching $37 a barrel, down 55 cents, or about 1.5% from Friday.

Calmer Waters From Troubled Oil

Prices may remain high, but could drop even more as higher production from the Organization of Petroleum Exporting Countries arrives as promised next month. That's especially likely if the transfer of power in Iraq reduces terrorist activity in that region, both in that country and in Saudi Arabia, the world's largest oil producer, which is now pumping 9.1 million barrels a day.

"This is not a fundamentally supportable price at $37," says Sarah Emerson, an energy economist and managing director at Energy Security Analysis in Wakefield, Mass. "There is plenty of crude around and our imports are going to stay high. We're absorbing a lot of crude and building a lot of inventory."

The most recent inventory report from the Department of Energy showed U.S. crude oil stocks at 305.4 million barrels for the week ended June 18, the highest level since Aug. 2, 2002. Equally important, inventories are just 4.5 million barrels shy of the five-year average for this time of year, and the closest to the middle of the average range that they have been since October 2003.

At $37, a barrel of crude oil cost $5.16, or 13, more than at the start of the year, but is still 13% less than the record closing price of $42.33 set June 1, when jittery traders and speculators reacted to another terrorist attack against the oil industry in Saudi Arabia. The incident came two days before OPEC made a critical decision to increase production, promising another 2.5 million barrels a day.

Iraq, Saudi Not Secure -- But Not Exposed

While further attacks on oil installations in Iraq and Saudi Arabia could quickly displace the market's fragile stability, oil and security experts say it's important to note that terrorists have chosen so-called soft targets, such as foreign workers and hard-to-defend pipelines, rather than oil fields, processing centers and other critical points in the supply chain.

"You're not going to blow up a refinery with a truck bomb, because you can't get it into a refinery," says Emerson, who points out that terrorists would likely need to use shoulder-launched missiles or crash a plane into a processing center to inflict long-term crippling damage.

"Whenever there's any damage, it's repaired in a few weeks," says John Lichtblau, chairman of the Petroleum Industry Research Foundation in New York and a veteran OPEC watcher. "It's easy to blow up a pipeline, but it's also not that difficult to fix it. If they get back to 1.7 million barrels, 1.8 million barrels a day, they aren't that far off from where they were before the war," he said, referring to Iraqi production.

A spate of car bombings and attacks on both U.S. occupying forces and Iraqi supporters of the new government have marked the weeks before the handover of sovereignty to a government that is to be led by former Baath party activist Iyad Allawi. But experts say Iraq's major oil installations are hard to reach and generally well defended. Still, few predict a smooth transition for the interim government.

"It's not a cosmetic move, but it is not going to change the security situation," says Anthony Cordesman, an analyst at the Center for Strategic and International Studies, a Washington think tank. "What you'll have is a whole set of measures to accelerate the training and equipping of Iraqi security forces to assume that role."

While this is a far from rosy outlook for Iraq's oil industry now and in the future, the market seems to be grasping that recent attacks have been disruptive, rather than crippling, and is learning to behave less reactively, particularly as oil inventories build in the U.S.

"I think it's an important distinction," says Michelle Billig, an energy industry expert and fellow at the Council on Foreign Relations. "In some way, this might indicate

terrorists' inability to attack a major artery. On the flip side, violence in general still causes market jitters -- it used to be sparked by simple violence in the Middle East in general, just with unrest in Israel."

Lichtblau says the market still generally doesn't count on steady supplies of Iraqi oil, which peaked at about 1.8 million barrels a day before a pair of pipeline attacks shut down production in early June. Repairs brought that back to about 700,000 barrels to 1 million barrels a day -- depending on estimates -- but Lichtblau and others say serious improvement and new investment are needed to return to the 3-million-barrel-a-day level Iraq produced before the first Gulf War.

Those are years away, even though many major multinational oil companies had agreements with Saddam Hussein's regime they would like to revisit, says Emerson. "I don't see any oil companies that want to come in and build something, then have it blown up."

In Saudi Arabia, the absence of large explosions doesn't mean the kingdom is calm and politically secure. But long-time Saudi watchers say security forces can defend its oil installations, and threats to foreign workers have less impact than short-term trading behavior would indicate.

"Aramco has been very successful in the Saudization of the company," says Emerson. "Only 10% to 15% of their employees are foreigners, as opposed to 30% to 35% for the rest of the country. The idea that all these foreign oil executives and key personnel are going to leave the country and the Saudis won't know what to do doesn't make sense to me."

Saudi security will be able to preserve the oil industry's essential security, says William Nash, a retired U.S. Army major general who is now a senior fellow at the Council on Foreign Relations. He spent several years helping train the 75,000-man Saudi national guard, which he describes as "very competent and determined."

Protecting the sprawling complex of an entire oil infrastructure, however, can't be done. "It's a very large, dispersed set of potential targets that make 100% defense impossible against a determined enemy, as the best armed forces in the world have found out in Iraq," Nash says. "The Saudi guard's mission is to secure particular key land complexes, and I have no doubt that if deployed and ordered to establish an active defense, they would do a reasonably good job, given the difficulty of the task."

Pump It Up

The difficult task the Saudis have already accomplished is their somewhat surprising feat of taking on a statesmanlike role in their unofficial leadership of OPEC, claiming credit for the 2.5-million-barrel increase the cartel approved at the beginning of the month.

The new oil is starting to make it into domestic inventories, as the DOE report suggests, but the market is profoundly conscious that the world's current 80 million-barrel-a-day demand -- about half of which comes from the U.S. -- could easily disrupt a still-fragile balance.

Experts give the Saudis their due for the new oil, although many suggest that the recent rise in prices could have been averted had OPEC increased its production quota last year. What's important, they say, is the Saudis' recognition that OPEC can still enjoy the benefits of higher prices without gouging an oil-thirsty world.

"I don't think the Saudis have stuck it to us," says Emerson. "I think they made a mistake last year, but since then they've actually kept production fairly high and really haven't put the screws to the consumer."

Lichtblau says the Saudis could eventually increase capacity to 12 million to 13 million barrels a day, from its current level of more than 10 million.

"There's no oil shortage, but the market is tight, and if anything goes wrong, it could immediately affect the price," he says.

Prices eased last week when the Norwegian government intervened to end a strike by oil workers, which threatened to put a serious dent in its production of more than 3 million barrels a day, the bulk of which is exported. But Lichtblau says civil unrest in Nigeria -- another OPEC member -- could affect production of its estimated 2.2 million-barrel-a-day output.

"By and large, OPEC has acted reasonably, and taken the stance that its role is to supply the world with the oil it needs at reasonable prices," he says. "They are trying to enforce that policy. They weren't jubilant about that $42 price -- they didn't want it.

"Nobody is criticizing OPEC. Nobody's blaming it for the current situation, which is very different from previous crisis periods."

No Longer Oil or Nothing

What's also different is that the most recent price spike hasn't sounded alarms for the U.S. economy. While domestic demand for oil is keeping the market tight, many economists think that high energy prices matter less now than they used to.

"In the past, energy price increases were longer and were bigger on a percentage basis, and the Fed reacted to those by tightening monetary policy," says Malanga. "My own bias is that this time the Fed has not reacted to the price of energy, which I think was smart. I think their whole measured and gradual approach to interest rate adjustments is appropriate in this context."

He says people are still willing to pay more for gasoline, though he rejects other economists' arguments that prices are still relatively low when adjusted for inflation.

Malanga says consumers don't make that distinction and simply don't like higher prices. "I think the economy isn't reacting to the inflation-adjusted price of energy, I think it's reacting to the price of energy," he says.

The average retail price of gasoline is at $1.92 a gallon, down from the May average of $2.05, according to the Automobile Club of New York.

The connection between high energy prices and the stock market's performance may also be overstated, according to recent research by Ron Papenek, a strategist at RiskMetrics Group. He suggests that oil prices affect the stock market less than is commonly believed, and that only certain sectors, such as consumer discretionary stocks and energy stocks, demonstrate direct correlations to price fluctuations. He says a $10 move in oil prices in either direction would affect the benchmark

S&P 500

stock index only about 2%.

"There is a relationship, but it's small," he says. "It's just one in a list of multiple factors that are affecting the overall economy and overall levels of equities."

The S&P consumer durables sector Papenek tracked in his research currently includes blue-chip companies such as

Sears Roebuck & Co.

(S) - Get Report

,

Sony Corp.

(SNE) - Get Report

,

McDonald's Corp.

(MCD) - Get Report

and

Eastman Kodak Co.

(EK)

.

While energy stocks do rise with oil price hikes, "certainly other factors have a more significant impact on the broader market -- currency levels and interest rates especially."

Perhaps more importantly, the Federal Reserve Board is taking a hands-off approach, says Richard Yamarone, an economist at Argus Research Corp.

"

Chairman Alan Greenspan just said last week that it wasn't a predominant issue," he says. "I don't think it's on top of their worry lists at this time. It's fading off the radar screen and will not be problematic in the third and fourth quarters."

Malanga says that while the security situation still means the markets -- and, by extension, consumers -- are paying a $10 "fear premium," the market is settling down. Although people will pay more for gasoline and other energy, higher prices won't serve as a brake on growth. If, as Malanga believes, oil prices have peaked, he predicts that the core rate of inflation will continue to improve, providing a little relief for consumers, who may then increase their discretionary spending.

"I think it's a structural adjustment we're undergoing, but I think we've also reached equilibrium from the last spike," he says. "I don't think a longer-term adjustment upward in the global price of oil will be harmful to the global economy."

In the end, it's been the major oil companies who've seen the most lasting benefit, according to Fadel Gheit, an oil and gas stock analyst at Oppenheimer & Co.

From

Occidental Petroleum

(OXY) - Get Report

, which paid down $5 billion in debt, to

Devon Energy

(DVN) - Get Report

, which retired $3 billion, energy companies have taken advantage of market conditions to balance their books, he says.

"Previously, their wildest expectation was $27 a barrel," he says. "This is all wind in their sails and they're enjoying it while it lasts. It's really put the industry on much more solid footing than ever before. They are printing money and can't get to the bank.