For the two years that have passed, the global prices of oil have fallen to such levels that have surpassed the 1990’s fall. They still continue to fall with no one having an idea as to when a peak will be experienced again. In June 2014, a barrel of Brent crude oil went for USD 110. Surprisingly, this went down to USD 60 by early 2015. As at now, it is going for USD 30, a value that was seen last in 2004. The situation is quite a breathtaking one.
This reduction has had its toll on the financial markets. The industries and factories have equally been hit hard by the crushing oil prices. In this article, we explain the contributing factors to this kind of decline.
Why the prices have been dropping so fast
The question as to why the oil prices have been declining so quickly is quite a complicated one. The demand and supply factor remains the influencing mechanism. Here are the contributing factors to the decline:
There is a simple rule in economics while evaluating the prices of goods; when the supply is low, and the demand is high, the prices of the goods go up. Equally, when the supply is high, and the demand is low, the price of the goods decreases. The same rule applies to the oil prices. By mid-2014, the demand for oil globally began to reduce. The economy of China was stumbling, US oil production continued to rise and rise while Europe, on the other hand, continued to reel from the Eurozone blander. Iraq and Libya similarly brought more oil online.
With these kinds of factors in play, Saudi Arabia and other OPEC members were expected to cut down on their production. Whenever a situation such as this has risen in the past, they have always reduced on production. Surprisingly, this did not come to pass. Saudi Arabia was forced to increase its production in an attempt to hold strongly to its share in the market. That was the starting point of interesting situations in the oil prices.
The decision by Saudi Arabia not to reduce its output by late 2014 has seen the oil prices continue tumbling and falling till now. The supply has continued to be high while the demand on the other side has been weakening. That s the basics of the matter, as long as the supply continues to plummet, the demand will be decreasing significantly. Brent crude oil is usually used as the basis for measuring oil prices. Who could have thought that it could reduce from USD 110 in June 2014 to USD 30 in late Jan 2016? The oil producers will have to loosen their tough stands on continued production of petroleum.
Loosening the stands could however not be something that will happen soon considering the strong statements coming from key players in the market such as Saudi Arabia. Reports coming from the Saudi officials indicate that they are not ready to cut production. They fear that if they do so, and the prices go up, their competitors will stand to gain more. They, therefore, would rather the prices to continue going lower. Some analysts consider this as a bluff as we wait to see for how long they can stand the declining prices.
In early January, IEA stated that oil prices are likely to go lower this year if Iran increases its oil production than it is expected. In a scenario where Iran brings on board 600kb/d while the other producers retain their current production, the prices will slide will push much lower. There are expectations that Iran may become a major exporter again.
Russia is equally skeptical about reducing its oil production. For every dollar fall in oil prices, Russia loses $2 billion in revenues. The failure of the oil prices to recover leads to a further shrinking of Russia’s economy. In spite of this, Russia has not shown any intention of reducing its production of petroleum. If the sentiments of its Energy Minister are anything to go by, their position is that the reduction may cause the importer countries to increase production. What this translates into is that they will lose their niche market. The falling oil prices, coupled with Western sanctions have hit the country hard.
The primary reason as to why the oil prices have declined is that the supply has increased while the demand has gone down. However, other factors do contribute to the plummeting costs.
Diplomatic problems could also be seen as a cause, especially within the OPEC. Algeria, Iran, Ecuador and Ecuador have been of the opinion that the cartel cuts production in an attempt to strengthen the prices. Saudi Arabia, United Arab Emirates, and the Gulf allies do not borrow this view. In contrast, Iran is producing more while there are expectations that Iran will become a major exporter again.
OPEC is a cartel of oil producers. Their unwillingness to intervene and stabilize the prices is contributing to a bigger percentage in the reducing prices.
The question that stands out significantly is that; who is to gain and can the oil prices recover? The consumers will without any doubt benefit by purchasing low price fuel. The producers on the other hand lose as their profits go lower.
Can the oil prices recover?
We should not be hopeful if this is happening anytime soon. The rate at which the production is declining in the US and the OPEC members is small. Hopefully, that may change this year.
As the economies of some countries begin to recover in the next year or two, so does the demand for oil.
Oil has always undergone cycles. There are times when there is a peak and at times it experiences lows. This will indeed come to an end in one or two years, depending on the measures that will be put into place. One thing for sure is that the decline has had the greatest impact on major oil exporters. Continued fall may make their economy fall into recession