“The frackers did labor and toil
To extract it out of the soil
But OPEC production was high
And demand less than supply
So down went the price of the oil.”
Before we start looking at the repercussions of the precipitous drop in the price of oil over the past year, let’s first set the stage in this post by putting the price drop into an historical context and understanding the factors that led to its occurring.
This graph shows historical crude oil prices per barrel for the past 10 years, trading at $49.07 as I post this article:
This graph shows historical prices for gasoline going back to 1991:
It is worth noting that the significant oil price drop of the past year is fundamentally different than the one that occurred in 2008 in one key way, and I haven’t seen a single article in the news that discusses it. When the 2008 price drop occurred, oil prices had been above $80/barrel for only about a year. When the 2014 price drop occurred, oil prices had been near or above $80/barrel for around 4 1/2 years.
When oil prices are above $80/barrel, investment in higher cost oil extraction techniques, as well as in alternative fuels, becomes more economically viable. With a sustained period of oil prices at that level for over four years, business plans have been completed, companies have been funded, large numbers of employees have been hired and relocated, houses have been purchased, and so on. If the current price decline is long-lived, then the number of employees today who will find that their jobs are no longer economically viable will vastly exceed the number so affected during the oil price fallout of 2008.
So now that we’ve placed the oil price drop into an historical perspective, let’s take a look at the why the price drop has occurred.
This December 16, 2014 two minute video from the Washington Post does a pretty nice job of explaining in simple terms why the price of oil has dropped (you’ll need to manually stop the video after it finishes, otherwise it just keep on playing more stories from the Washington Post):
A December 4th, 2014 article Why the oil price is falling from The Economist elaborates further:
Four things are now affecting the picture. Demand is low because of weak economic activity, increased efficiency, and a growing switch away from oil to other fuels. Second, turmoil in Iraq and Libya—two big oil producers with nearly 4m barrels a day combined—has not affected their output. The market is more sanguine about geopolitical risk. Thirdly, America has become the world’s largest oil producer. Though it does not export crude oil, it now imports much less, creating a lot of spare supply. Finally, the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price. They could curb production sharply, but the main benefits would go to countries they detest such as Iran and Russia. Saudi Arabia can tolerate lower oil prices quite easily.
Also worth reading is this Janaury 23, 2015 article from VOX: Why oil prices keep falling — and throwing the world into turmoil.
And this February 7, 2015 article from Reuters explains that oil’s dramatic price fall since mid-2014 cannot be explained by changes in production and consumption alone… hedging and energy firms’ high debt levels also play a part. See: Oil price fall exacerbated by hedging, energy firms’ debt: BIS.
This Business Insider article from today, February 11, 2015, notes that US crude oil inventories are at their highest level in at least 80 years.
That pretty much covers it. And in my next post, we’ll take a look at some different points of view about where the price of oil is likely to head in the future.
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