A brief overview of a complex topic
Plummeting oil prices call for our attention, but many of us don’t understand why the change in price – a major topic of interest – is happening. There are countless factors to consider. Oil prices are influenced by supply and demand — and by expectations on where future investments should be taking place. Supply can be influenced by things such as weather, such as the Northern Hemisphere’s spike in usage of oil in the winter, and geopolitical conflicts.
From around 2010 to mid-2014, world oil prices were fairly stable at around $110 per barrel. The high price, compared to those of today, was due to the large demand for oil by countries that consumed a lot of oil, such as China, and those experiencing geopolitical conflicts, of which Libya and Iraq are two such examples. Because oil production couldn’t keep up with the large demand from countries around the world, oil prices spiked.
As oil prices jumped, this led energy companies in Canada and the U.S. to try to profit from extracting oil in difficult-to-reach areas. This was seen in the increased fracking and horizontal drilling of shale formations, as well as the heating of oil sands to extract crude oil. With this boom in oil production, America has become one of the largest oil producers in the world; North Dakota and Texas were two large players in this climb. Despite this boom, crude oil is not exported, meaning that America imports much less than it used to and creates a large extra oil surplus. Yet, there are even more reasons to why oil price has decreased.
The world is also currently experiencing a decrease in oil demand, due to weak economic activity and an increased switch to other fuels. The demand for oil in Asia and Europe began to weaken as emerging market economies cut imports due to weak Gross Domestic Product (GDP) growth. This was noticeable in November of last year, as weak demand for industrial raw materials could be seen in Japan, China, and Europe. In Libya, production increased around mid-2014, which then acted as an important downward pressure on Brent (North Sea) oil price, further aiding in decreasing global demand, especially in Europe and Asia, as Libya’s output did not decrease.
Brent is a major trading classification for sweet crude oil, among others such as Organization of Petroleum Exporting Countries (OPEC) Reference Basket or West Texas Intermediate (WTI). These classifications act as benchmarks for the price of oil worldwide, and the Brent-WTI price spread has narrowed considerably as of late.
Another factor that has influenced oil prices is that the Middle East, Saudi Arabia, and their Gulf allies decided not to sacrifice their own share prices and cut production back, but rather continue with their level of production. This brings us to the influence of OPEC. As a collection of the largest oil-producing nations, OPEC had their last big meeting in late 2014, at which a heated debate took place on what to do about the plunging drops in oil price — a remarkable 30 per cent drop over the last five months. There were some OPEC members, such as Venezuela and Iran, who wanted the group to cut output, while others disagreed.
This is an important issue, especially for those countries who are heavily invested in oil production, as government spending has led to economies in precarious positions. In Venezuela, for example, inflation is coming to be about 60 per cent, and their economy is hovering close to recession. On the other hand, Saudi Arabia, OPEC’s most influential member and the world’s largest oil exporter, shows no desire to cut back its production; however, their tactic seems to be letting the price drop so that high-cost producers will be hit hard.
As the game of chicken continues, the world economy will persist in facing a drop in oil prices. What this means for the boom in the US and whether the price of oil will stabilize is yet to be seen; at present, no one knows what potential events could influence oil production worldwide.