Causes Of The Current Fall In The Price Of Crude Oil In The Global Market Research Paper Example

The most exciting story in the world of energy continues to be the low price of oil in the global market. As consumers flock to the gas pumps for prices slightly up from under $2, the repercussions are felt in the countries that produce oil like Russia, Venezuela, and others (Plumer, 2015). Many people wonder why the price of oil plummeting and why it’s staying so low. In June of last year, Brent crude went for about $115 per barrel. In January 2015, the price had dropped by over 50 percent to $49 per barrel.
The price of crude oil is influenced by factors ranging from weather, the status of geopolitics, investments in the market, and others. But the main driving factors are the supply of energy, the global economy, and the value of the currency in respective countries (Burns, 2013). The heaviest influences pertaining to the global economy are from China, the European Union (EU), and the United States. The scarcity of energy is reflected in numbers for depletion and reserve accretion, and the power of the U.S. dollar is highest for worldwide purchasing.
There are four laws of supply and demand: 1) if demand remains stable and the supply increases, the surplus product results in a lower price, 2) if demand increases and supply remains stable, the shortage in the product increases prices, 3) if demand stays steady and supply increases, the resulting surplus lowers prices, and 4) if demand decreases and supply stays the same, the resulting surplus lowers prices (Burns, 2015).

The Influences on Oil Prices

In order to understand the reasons why the price of crude oil plummeting over recent months, it is necessary to look deeper in the relationships between the factors having the most effect. For the past 10 years, the price of crude oil has been high due to the demand in China and other similar countries. At the same time, major oil-producing countries like Iraq were experiencing internal problems that inhibited the production of oil. In other words, demand was up and supply was down with the consequence that prices soared. However, the cost of oil motivated corporations to start drilling in Canada in Alberta’s oil sands and in the United States in the shale formations of North Dakota. This increased the supply in these countries internally, resulting in growing inventories.
Recently, the demand in America, Asia, and Europe has become more stable in a reaction to softer national economics and attention to the development of more effective methods (Gaspricesexplained.org, 2015). By the end of 2014, the supply of oil in the world was rising higher than the demand for it (Chart I). Oil remaining unsold was placed into inventory for

Graph I. Spot price of Brent Crude, updated on January 23, 2015 (Plumer, 2015)

future use. In September 2014, the cost of oil began to drop. At that time, it was expected that the world’s largest producer of oil, OPEC (The Organization of Petroleum Exporting Countries), would reduce production in order to decrease supply and encourage higher prices. Some of the states included in OPEC, such as Iran and Saudi Arabia, looked to balance their budgets from the income. However, at their meeting in November 2014, Saudi Arabia resisted surrendering its share of the market and rejected the idea of reducing oil production; the idea was that by keeping oil prices low, the interest in American drilling in shale fields would decrease.

The Impact of Crude Oil Prices

There is a reciprocal effect of the demand for oil and the price of it. As the cost for crude oil increases, so does the price for gasoline. The demand for gasoline increases the cost of the oil. When the United States experienced poor economic activity along with other countries in 2008 and 2009, people tightened their belts and changed their lifestyles to drop their need for gasoline. The lessened demand promoted a decrease in prices. Global economies are recovering, but North Africa and the Middle East are experiencing civil unrest which is effecting the production of oil in those areas. As people resumed their consumption of gasoline and other related oil products and the supply remained low, prices rose. Finally, the recent drop in oil prices is a result of an increase in oil production that outdistanced the need for it; this production came primarily from the United States. This production has compensated for the unexpected shortages from other global locations and helped keep prices low, promoting financial benefits to consumers.

The Supply of Oil

The production of oil worldwide was 1.6 million barrels per day in 2012 and rose to 3.5 million barrels per day in May 2014. By November 2014, the supply had dropped to 3.3 million barrels per day. The Energy Information Administration (EIA) states this is the most disruptive supply levels have been since 1990-1991 when the Iraq-Kuwait War pushed the cost of oil to record highs (Asghedom, 2014). The EIA predicts that OPEC will resume production in 2015 to approximately 2.3 million barrels daily.

Changing Demands for Oil

The global demand for oil hit its highest in 2007 when 86 million barrels daily were consumed (gaspricesexplained.org, 2015). However, in 2009 it decreased by over one million barrels daily before resuming consumption in 2010.

Graph 2. Supply and Demand 1st Quarter 2009 through 1st Quarter 2015 (Plumer, 2015)

Strength of the Exchange Rate
The American dollar continues to be a strong currency in relation to the Japanese yen and the EU’s euro. This results in significantly lower crude oil prices in the United States than in Europe or Japan. The benefits of increased oil production are seen more in countries with strong currencies than in nations that don’t.
There is a correlation between the value of the dollar and oil production in the United States (Burns, 2013). The euro was introduced in 1999 and began to increase in value. At that time intermediate crude oil out of West Texas was bringing less than $20 per barrel. As the euro edged out the dollar, the price of oil began to increase. The value of the dollar decline again due to the expense of the Iraq War in 2003; American currency had declined in value by 20 percent and crude oil had leapt up 30 percent. By the end of 2004, the dollar was trading at $1.35 against the euro and oil was going for $43 per barrel. This trend continued until a peak was reached in July 2008 of $146 per barrel for oil and the euro valued at $1.604.

Speculation and Investments

Smart investors put their money where it will earn the most return. Since 2010, income from oil, natural gas, and manufacturing in the United States averaged about seven cents of every dollar of sales with eight cents for manufacturing (Shapiro & Pham, n.d.). In late 2014, oil and gas averages rose to 8.9 cents while manufacturing climbed to 9.5 cents as a result of a weak American economy beginning to rally. The benefits paid to shareholders allow for companies to buy into new technology that investigate optional sources of energy. Mutual fund accounts, pension plans, and IRAs rely heavily on returns on investment into oil and gas companies.
Regardless of disturbing activity in the Middle East, Libya and Iraq began to bring oil production back to previous levels (Putnam, 2015). Investors in long-term strategies such as endowments and pensions started to move asset allocations into the stock market. Energy funds that included Exchange Traded Funds and Exchange Traded notes indicated a positive outlook regarding the price of global energy.

Impact of Politics on Oil Prices

The United States and Canada entered the oil production market when fracking and horizontal drilling in Texas and North Dakota and steam extraction techniques in Alberta resulted in crude oil that was able to be processed. Since 2008, America has added 4 million extra barrels of crude oil daily; this is significant considering the entire world produces 75 million barrels per day (Plumer, 2015). However, this production has barely impacted oil prices worldwide due to political problems in Libya and Iraq. The European Union and the United States imposed oil sanctions on Iran, decreasing the demand for exported oil. The block decreased available oil by 3 million barrels each day. The influence of these geopolitical conflicts decreased as internal oil production increased Canada and the U.S.
In addition, the demand for oil in countries like Germany and China has begun to remain stable. American consumption is also level with the introduction of more gas-efficient automobiles in use. Also, Iran and Indonesia have pulled back subsidies for consumers of oil. This was the beginning of falling oil prices and demand was not up to expectation and supply consistently rose. From OPEC’s viewpoint, they are now having a price war with the United States. It’s more expensive to produce oil in Texas and North Dakota than it is to import it from Kuwait and Saudi Arabia. As oil prices remain low or drop even further, American companies may close their doors. Shale drilling required approximately $60 per barrel to remain profitable. New fracking wells are needed to replace old ones constantly; when oil prices fall, drilling activities are reduced. From December 2014 to January 2015, the number of rigs in Texas’ Permian Basin has decreased by 15 percent. In Canada, production costs are all in the beginning so continued production will remain relatively inexpensive for years.

Conclusion

After reviewing the available information, the cause of the current fall in the price of crude oil in the global market is probably based only 30 percent on demand and 70 percent on supply. Considering the attitude of OPEC and the production of oil in the United States, the low prices should not have significant impact. Supply will continue to increase thanks to stable income from investors. However, if tension erupts in Libya and Iraq again, oil production may decrease (lower supply = higher prices). The economies Asia and Europe may recover and increase demand (higher demand = higher prices). However, there were notices that Iraq and Russia are exporting more oil than ever and prices dropped even more. This may be the opportunity America has been waiting for to invest in more energy-efficient technology to decrease dependence on foreign oil.

References

Asghedom, A. (2014). U.S. liquid fuels production growth more than offsets unplanned supply
disruptions - Today in Energy - U.S. Energy Information Administration (EIA). Eia.gov.
Retrieved 5 March 2015, from http://www.eia.gov/todayinenergy/detail.cfm?id=17731
Burns, S. (2013). US Shale Oil Production Causes WTI Price to Fall. OilPrice.com. Retrieved 5
March 2015, from http://oilprice.com/Energy/Oil-Prices/US-Shale-Oil-Production-
Causes-WTI-Price-to-Fall.html
Gaspricesexplained.org. (2015). Gas Prices Explained. Retrieved 5 March 2015, from
http://www.gaspricesexplained.org/
Plumer, B. (2015). Why oil prices keep falling — and throwing the world into turmoil. Vox.
Retrieved 5 March 2015, from http://www.vox.com/2014/12/16/7401705/oil-prices-falling
Putnam, B. (2015). Why the Spectacular Fall in Oil Prices? | OpenMarkets.
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Shapiro, R., & Pham, N. Who Owns America's Oil and Natural Gas Companies: A 2014 Update.
SSRN Journal. doi:10.2139/ssrn.2540597