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There are several economic and political theories behind the falling oil price. Technically it is a story of supply and demand.

Our focus in this article will be mostly on the economic factors as economic factors are objective whereas political theories and manipulative conspiracies are speculative, subjective and usually cannot be supported with concrete demographics and statistics.

Falling oil price is surely benefiting consumers as it has freed up cash for families, they are enjoying the additional disposable fund available at their end. But the same phenomenon is severely hurting economies relying on oil exports thereby causing a socioeconomic unrest and it will be equally costly to those employed in oil industry all across the world. Research and the graph indicates that the price of oil has been dropping since 2011 and whatever is happening today should not come to us as a surprise, this was very well expected and projected then to be in the store.

 

10 years6 months

 

The first graph does not come to us as a surprise as this is not the first time the price of crude oil has plummeted in the last decade. On the other hand the second graph looks quite intense as there is a rapid fall over last 6 months. It is hard to believe, from $115 to $60 per barrel, the price is falling really fast as the Domino effect or the Ripple effect has kicked in.

The stock of oil companies is following the suit.

The prime economic reason for this fall is the overall decrease in demand for Crude Oil. In a free economy, market always reaches an equilibrium price at the point where the supply curve intersects the demand curve. In our current case the demand curve has shifted from D to D1 supply being constant and hence the price has fallen from P to P1.

demand curveThere are multiple economic reasons for the decrease in the demand for Crude Oil.

  • The decline in the oil price can be largely attributed to the sharp increase in oil production in the U.S., which has led to reduction in imports by the world’s largest oil consuming nation.
  • Energy efficient vehicles and equipment is gaining popularity and is widely used in countries such as Germany, Italy, France, Japan, China, Canada and United Kingdom. Government offers tax incentives and rebates to encourage the usage.
  • Dollar as a currency has strengthened in the recent past thereby leading to an increase in its purchasing power.
  • On the other hand the currency of Russia (Ruble), one of the top exporters of Crude oil has weakened since 2011. Oil is traded in Dollars and compared to five years ago, today one can buy more oil from Russia with the same amount of dollars.

Russian Ruble

Slowing down of economic activity mainly in China being the world’s no. one importer of Crude oil.

  • For the first time since 1998 China has missed its annual growth target. The GDP of China is the lowest in five years. The third quarter growth rate is down from 7.5% as compared to the second quarter.

Lowering of oil imports by the United States.

  • Oil consumption and imports in the U.S had peaked in 2008 which resulted in a steep hike in the prices of Crude oil and products. The consumption, demand and imports has been continually falling post 2008 till 2011 and once again from 2011 till date. The fall in the imports is driven by new oil drilling largely domestic shale gas production. The “shale revolution” has stimulated huge production of oil and natural gas in the United States.

The production levels have peaked and the U.S today produces about nine million barrels a day compared to five million a day in 2008, this spike of four million is more than what a Iran or a Iraq produces in a day.

This is good enough to wipe out the entire market share of Iran or Iraq. The ‘shale revolution’ is the  result of advances in oil and natural gas production technologies such as horizontal drilling and hydraulic fracturing. Reduction  in imports also helps the trade deficit of the United States.

On the other hard Political theories indicate that this is the western world’s answer to Russia and Iran, maybe Saudi Arabia with OPEC on its side is taking a stance against Russia and Iran.

Or is it Saudi Arabia’s plan to impact the domestic production and hike oil imports of the U.S.? As we speak, the United States is the world biggest shale producer and deploys a sophisticated technology to dig shale gas. China and Canada also flaunt to have a substantial reserve and reliance on Shale. OPEC along with Saudi Arabia through its pricing strategy might be hell bent on impacting the Shale industry within the U.S., forcing it to get back to its big fat oil imports.

We can clearly see in the graph that there is an increase in crude oil production causing a decrease in import of crude oil. The domestic production is soaring and at the same time the consumption is on a reducing trend.

In 2006, the U.S. imported about 13.4 million barrels a day of crude oil products; whereas recently the net import number has plummeted to merely 4.7 million barrels a day.

 

US Crude Oil Import

Saudi Arabia has been enjoying its positive deficit for a long time plus the cost it actually incurs in order to dig oil from the well can be as low as $8 per barrel hence it can withstand the adversity of the falling price for sometime but this is not sustainable in the long run. The situation is equally bad or even worse for other oil export reliant economies such as Nigeria, Venezuela, Kuwait, Ecuador, Iraq, Columbia and Brazil. They are rapidly losing their market share and holding on to the remaining part of it at a much lower price. These economies are heading for a depression, some are at the brink of financial crisis, budget crisis and currency crisis.

Oil happens to be the vital commodity to the entire mankind and both our survival as well as our progress thrives on it.

Should we call it mankind’s inherent greed of digging or advancement in technology but the supply of Crude Oil today has exceeded its demand and the price can be as low as $50 a barrel.

Oil projects are long term in nature and the investment takes place several years ago, digging of shale is a costly business, shale producers as well as oil export reliant economies will not be able to afford this fall. Eventually the supply curve will correct itself and once again we will be facing scarcity of oil and it is projected that the price of crude oil is likely to reach equilibrium at $80 per barrel by the dawn of 2015. Till such time consumers and commuters will reap the benefit of the falling price and the producers will suffer; after all it is an oily business.

References:

http://www.economist.com

http://america.aljazeera.com

http://www.businessinsider.com

http://www.eia.gov

http://www.nasdaq.com

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