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Why crude oil prices keep falling and falling, in one simple chart

13 January 2016 [15:14] - TODAY.AZ
For the past two years, global crude oil prices have been in free fall, and no one seems to know when the bungee cord will catch. In June 2014, you had to plunk down $110 to buy a barrel of Brent crude. By early 2015, that had plunged to just $60.

Today it costs just $30 to buy a barrel of oil — a level not seen since 2003. It's a staggering drop.

I've written a more in-depth history of the rise and fall of oil prices, but the crucial dynamic can be seen in the chart below, taken from the International Energy Agency's Oil Market Report. Since mid-2014, the world has been producing far more oil than anyone needs. Supply remains much higher than demand. So prices have crashed:

(International Energy Agency Oil Market Report)
A short history of the rise (and fall) of oil prices
This wasn't always the case. Between 2010 and 2014, as you can see above, oil demand was soaring around the world, as countries recovered from the financial crisis, but global production was struggling to keep up. Many older oil fields were stagnating. Conflicts in places like Libya and Iraq were restricting supply. Countries had to draw down their stockpiles, and prices soared to around $100 per barrel.

Those high prices, however, spurred more and more drillers in the United States to use innovative hydraulic fracturing and horizontal drilling techniques to unlock vast quantities of oil from shale formations in places like North Dakota and Texas. It's hard to overstate the impact of the fracking boom: US crude oil production has nearly doubled since 2010.

Eventually, supply caught up with demand — and then surpassed it. That's when the crash came.

By mid-2014, global demand was starting to slow down. Europe was still reeling from the eurozone mess. China's economy was starting to stumble. But the United States was still producing more and more oil. Iraq and Libya were also starting to bring back more production. So prices began sliding.

At that point, many people expected Saudi Arabia and other oil producers in OPEC to cut back on their own production to prop up prices, as they have in the past. (Conventional wisdom had held that Saudi Arabia needed $100 per barrel oil to balance its budget.)

Surprisingly, that didn't happen. Saudi Arabia decided to increase production in order to maintain market share, hoping that the subsequent fall in oil prices would crush US frackers, who require higher prices to stay profitable.

And that's when things got really interesting.

Ever since Saudi Arabia's decision to maintain output in late 2014, prices have kept tumbling and tumbling — largely because supply has stayed resilient and demand has been weaker than expected.

US drillers turned out to be far more adaptable to low oil prices than the Saudis thought — companies cut costs and boosted productivity in order to keep the oil flowing. (US production has stopped growing lately, but the decline has been far less severe than originally predicted.) Iraq has nearly doubled production since 2014 as it recovers from conflict. Thanks to the nuclear deal with the US, Iran is expected to start exporting more oil soon, further adding to the supply glut.

And in the meantime, major developing countries like China and Brazil have been mired in a slump, putting a damper on oil consumption. That's the basic dynamic. As long as supply far outstrips demand, oil prices will stay relatively low.

Those low prices are having all sorts of ripple effects around the world. Drivers in places like the United States, Europe, Japan, and elsewhere are suddenly paying way less for gasoline, which means they have more money to spend on other things. (Arguably, low prices have helped juice the US economy.) Oil producers like Saudi Arabia and Russia, meanwhile, are struggling to balance their budgets and seeing a major revenue hit. Oil companies themselves are watching profits evaporate. SUVs are coming back in style. And so on.

So when will oil prices rise again?
No one knows for sure. Or, if they do, they're laying bets in the financial markets rather than writing articles about it. Jad Mouawad of the New York Times recently took a look at various forecasts: Some banks project oil prices to keep plummeting down to $20 per barrel this year. Others expect a rebound to around $40 or $50 per barrel as the US shale boom tapers off and demand recovers.

Ultimately, the supply and demand dynamic is the thing to keep an eye on. And expectations matter a lot here. Whenever new data shows an unexpected boost in oil production or an unexpected drop in oil demand, prices tend to go down. Conversely, a surprise drop in supply or a surprise surge in demand will push prices back up.

So if, say, the cold war between Saudi Arabia and Iran heats up and somehow leads to disruptions that crimp production, prices could rise. (So far, that hasn't happened.) If low prices are harder for the US shale industry to handle than anyone thought, that could cause prices to rise even higher than forecast. If China's economy suddenly rebounds unexpectedly, that could have a similar effect. Or maybe Iran will do something that causes European Union and US oil sanctions to snap back into place. Alternatively, maybe low oil prices will persist indefinitely. It's a guessing game, and there are lots of plausible guesses.

/By Vox/

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