Things you wanted to know about falling global oil prices

Global oil prices have fallen sharply over the past one and half years.  This fall started in mid of 2014. From 2010 till mid of 2014, the oil prices were fairly stable above $100 per barrel. But now prices have fallen below $50 per barrel. For much of the past decade, oil prices were high- bouncing around $100 per barrel since 2010 because of soaring oil consumption in countries like China and conflict in key oil nations like Iraq. Oil production could not keep pace with demand so price increased. In the past also oil prices had fallen to various lows as shown in graph below:

Story behind fall in oil prices recently

Between 2010 and mid 2014 oil prices remained close to or above $100 per barrel, thus making drilling in unconventional areas(difficult to drill) profitable e.g. Arctic region by Russia, development of fracturing & horizontal drilling techniques in US for extraction in North Dakota(shale gas). During the same period demand was high from countries like China. US oil boom has little impact on the oil prices till now because the conflict in Middle East restricted/decreased the supply thus extraction from unconventional areas remained profitable. But it all started changing from mid of 2014 with Libyan rebels opening two terminals for export of oil, at the same time demand from Asia and Europe decreased due to slowdown in China and Germany. The United States also saw poor industrial demand for oil due to recession. At the same time countries like Indonesia and Iran have been cutting back on fuel subsidies. Also OPEC countries are not agreeing among themselves to decrease the supply because of fear of losing market share. Thus in short it is mainly due to mismatch between demand and supply. These all factors have led to sudden fall in oil prices. These factors can be summarised as below:

OPEC(Organisation of Petroleum Producing Countries) controversy

OPEC is an organisation of petroleum exporting countries. It was formed in 1960 and now headquartered at Vienna (Austria). Its mandate is to “coordinate and unify the petroleum policies” of its members and to “ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry. Almost 81% of proven oil reserves are located in these countries. Thus these countries play a very important role in oil prices.

OPEC countries are not ready to cut the oil production as they fear losing their market share. E.g. in 1980s Saudi cut its production to boost oil prices but it had little impact, and it also impacted its economy badly.

Recession

Recent slowdown in the Chinese economy in Asia and Germany in Europe, has led to weak demand from Asia and Europe. Similar is the case with other countries like US, India.

Shale gas boom

After the development of fracturing and horizontal drilling technique, there has been a shale gas boom in USA and Canada, with shale gas being drilled from Alberta and North Dakota.

Middle East Crisis

Earlier supply was reduced due to conflict in this region but recently rebellion held areas has opened terminal for export of oil, thus increasing the supply.

Renewable Energy share

There has been continuous increase in share of renewable energy. Cost of production of solar power has decreased drastically since 2009.

Impact of falling crude oil prices

On oil importing countries

Countries like India, which pays huge oil import bill, have been able to decrease their revenue deficit effectively. Recently India deregulated gas prices which saw decrease in its market prices after the deregulation, which was mainly due to fall in global gas prices which are linked to falling oil prices too.

On oil exporting countries

There has been a huge loss of revenue for these countries. Co-ordination among OPEC countries is declining with no one agreeing to decrease its production, especially Saudi Arabia, fearing decrease in their market share. Russia which earns 70% of its export income from oil and gas export has been hit hard with its currency (rouble) falling rapidly. Venezuela, one of the largest oil producers, has been reeling under high inflation (60%), with its economy on the brink of recession. Saudi, other Gulf producers like UAE, Kuwait have deep pockets of foreign currency and can run on deficit for several years. But countries like Iran, Iraq and Nigeria with greater domestic budgetary demands because of their large population sizes in relation to their oil revenues have less room for manoeuvre.

On growth of the economies

Low fuel prices will certainly decrease cost of production and may increase industrial output in the short run. Some analyst have pointed out that 10% decrease in oil prices will add 0.1% growth to economic output. China, Japan, India will certainly benefit from low fuel prices as they import large portion of their oil needs.

Impact on environment

Energy sector which accounts for the large part of carbon emission in the world, but share of oil in power sector has decreased from 25% in 1970s to 5% at present. Thus impact may not be as severe as it would have been in 1970s. Recent IPCC (Intergovernmental panel on climate change) report has revealed that lower prices has positive impact on environment, as oil exploration in unconventional areas like Arctic region, deep sea drilling will decrease because it involves high cost of production. But on the other hand low fuel prices may increase their use unsustainably thus causing global warming. Thus it has both positive as well as negative impact on the environment.

Future perspective

There could be decrease in oil supply if further conflict break out in the Middle East (ISIS). Europe and China could bounce back in near future and increase demand for the oil. Saudi Arabia may decrease its oil production. Any of these, if happens, would certainly take oil prices upward. If we see at the past, oil prices have always bounced back to normal level, but it is yet to be seen how much time it will take.

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