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The oil price crash is still the world’s biggest energy crash. This is wreaking havoc on oil-producing countries like Russia and Venezuela, bringing cheap gasoline back to the United States.
Oil Prices Going Up Or Down
But why does the price of oil continue to fall? In June 2014, the price of Brent oil rose to around $115 per barrel. As of January 23, 2015, it has fallen to more than $49 per half barrel:
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Here’s the short version of the story: For most of the past decade, oil prices have been high — hovering around $100 a barrel since 2010 — driven by rising oil consumption in countries like China and conflicts in major oil nations like Iraq. ‘stretched. Oil production in conventional fields could not meet the demand, so the prices rose sharply.
But beneath the surface, many of these dynamics were changing rapidly. High prices have prompted companies in the US and Canada to start drilling for new, hard-to-find crude in North Dakota’s shale formations and Alberta’s oil sands. Then, over the past year, demand for oil in countries such as Europe, Asia and the United States has fallen due to a weakened economy and new efficiency measures.
By the end of 2014, global oil supply was on track to grow much faster than actual demand, as shown in the International Energy Agency chart below. Much of the unused oil was simply stored for later. Thus, in September, prices began to fall sharply.
As prices fell, many observers waited to see if OPEC, the world’s largest oil cartel, would cut production to push prices up again. (Many OPEC nations, like Saudi Arabia and Iran, need higher prices to balance their budgets.) But at a big meeting last November, OPEC did nothing. Saudi Arabia has been reluctant to give up market share and has refused to cut production – hoping that lower prices will help stem the US shale boom. It was a surprise. Thus, oil fell freely.
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The collapse of oil prices is now lifting the global economy, affecting every country in the world. Low prices are great news for oil consumers in countries like Japan or the US, where gasoline has been the cheapest in recent years. But it is different for countries that rely on oil trade. The Russian economy is facing a potential crisis. Venezuela is in turmoil and may default on its debt. If oil prices remain low, even well-prepared countries like Saudi Arabia may come under severe pressure.
To learn more about how we got here and how an oil crash could affect countries around the world, read:
This Aug. 21, 2013, photo shows the pump (also known as the bowing donkey) near Tioga, North Dakota. (Karen Bleier/AFP/Getty Images)
To understand this story, we must first go back to the mid-2000s. Oil prices have soared because global demand – especially in China – and not enough oil production to keep up. This led to huge price increases, and oil hovered around $100 a barrel between 2011 and 2014.
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Nevertheless, as the price of oil has risen, many energy companies have found it profitable to start producing oil in places where it is difficult to drill. In the United States, companies have begun using methods such as fracking and horizontal drilling to extract oil from shale formations in North Dakota and Texas. In Canada, companies steam-heated Alberta’s oil sands to extract usable crude.
This led to the growth of “unconventional” oil production. The U.S. alone has added 4 million barrels per day of crude oil to the global market since 2008. (Global crude oil production is about 75 million barrels per day, so this is significant).
However, until recently, the US oil boom had little effect on global prices. This is due to the fact that at the same time, geopolitical conflicts flared up in important oil regions. There was a civil war in Libya. Iraq has faced threats from ISIS. The United States and the European Union imposed oil sanctions on Iran and reduced its oil exports. These conflicts have removed more than 3 million barrels per day from the market:
By mid-2014, these disruptions and conflicts no longer mattered. Production in the United States and Canada still grew rapidly, and world oil supplies continued to grow.
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More importantly, demand for oil in Asia and Europe suddenly began to weaken – thanks to the slowdown in China and Germany. In general, demand for oil is declining in many parts of the world. In the United States, once the world’s largest oil consumer, gasoline consumption has stagnated as cars become more fuel-efficient. At the same time, countries such as Indonesia and Iran are reducing subsidies for fuel users.
A combination of weaker-than-expected demand and steadily increasing supply has seen oil prices start to fall from a peak of $115 in June to around $80 a barrel by mid-November. And that was just the beginning…
Which brings us to OPEC, a group of oil-producing nations that produce about 40 percent of the world’s oil. In the past, the cartel sometimes coordinated production cuts or increases in an effort to influence oil prices.
At a major meeting in Vienna on November 27, OPEC members heatedly debated how to respond to falling oil prices. Some countries, such as Venezuela and Iran, wanted the cartel (mainly Saudi Arabia) to cut production to raise prices. These countries need higher prices to “break even” their budgets and pay for all the government spending they collect:
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On the other side of the argument is Saudi Arabia, the world’s second-largest crude producer, which has opposed production cuts and is willing to let prices fall.
Why did it happen? First, Saudi officials recall what happened in the 1980s when prices fell and the country tried to cut production to support them. As a result, prices continued to fall and Saudi Arabia lost market share. In addition, the Saudis indicated that they could live at lower prices in the short term. (The government built up $750 billion in foreign exchange reserves to finance the deficit.)
In the end, OPEC could not fully agree on a response and kept production unchanged. “For the next 6 months, we will produce 30 million barrels of oil per day and we will monitor how the market moves,” OPEC Secretary General Abdalla El-Badri said after the meeting.
This led to a further decline in oil prices. The price of Brent oil rose from $80 to $70 per barrel in a few days. In mid-December, it continued to fall below $60 per barrel, and below $50 in January.
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For all intents and purposes, OPEC is now engaged in a “price war” with the US. This means that it is relatively cheap to pump oil from places like Saudi Arabia and Kuwait. But it’s more expensive to extract oil from shale formations in places like Texas and North Dakota. Thus, as oil prices continue to decline, some US producers may become unprofitable and go out of business. Oil prices will stabilize. At least OPEC members hope so.
By January 2015, it was clear that low prices in the US and Canada were starting to pinch producers. The only real question is how much damage it will do.
Analysts often focus on an indicator called the “breakeven price” for oil drilling projects – the price of oil needed to make a reasonable profit for the project. ScotiaBank has estimated break-even prices for various shale and oil sands projects across North America:
US shale projects are particularly vulnerable when oil prices fall below $60 a barrel. Fracking wells deplete quickly—production drops by about 65 percent after the first year—so new wells must be drilled constantly. So when the price falls, many companies can respond quickly by cutting back on new drilling. Already, firms are pulling out of places like Texas’ Permian Basin, and the U.S. rig count fell 15 percent from December to January.
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But not everyone will leave at once: some companies will have to continue drilling because costs have fallen. Others may try to reduce their costs. It really varies from company to company. Also, the situation is different in Canada: oil sands projects have huge initial costs, but once they are paid off, they can continue to produce cheap oil for decades.
All of this makes it difficult to predict how it will shake out or where global oil prices will bottom out. The U.S. Energy Information Administration still expects total U.S. oil production to rise another 700,000 barrels per day in 2015 — but that’s slightly below the forecast when prices were higher. Let’s see if this is true.
Russia: The situation in Russia is getting the most attention these days. The country is very dependent
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