For the last two years, global oil prices have been in free-fall, and no one seems to know when the bungee cord will catch. In June 2014, you had to plunk down $110 to purchase a barrel of Brent crude. By early 2015, that had dropped to $60.
Today, it costs less than $30 to buy a barrel of oil — a level not seen since 2004. It’s a breathtaking decline.
I’ve written a longer explainer of the rise and fall of oil prices, but the basic dynamic can be seen in the chart below, from the International Energy Agency’s Oil Market Report. Since mid-2014, the world has been producing far more oil than anyone needs:
Note that “oil supply” includes crude oil and condensates (which account for about 80 million bpd), but also natural gas liquids, refinery products, and biofuels. (IEA Oil Market Report)
Oil supply* (in green) remains much higher than demand (yellow) — about 1.5 million barrels per day higher — with the excess getting saved for later in stockpiles. And, according to the IEA, that glut is currently expected to persist for the rest of 2016: “Unless something changes, the oil market could drown in over-supply.”
A short history of the rise (and fall) of oil prices
This wasn’t always the case. Between 2010 and 2014, as you can see above, oil demand was soaring around the world, as countries recovered from the financial crisis but global production was struggling to keep up. Many older oil fields were stagnating. Conflicts in places like Libya and Iraq were restricting supply. Countries had to draw down their stockpiles, and prices soared to around $100 per barrel.
Those high prices, however, spurred drillers in the United States to use innovativehydraulic fracturing and horizontal drilling techniques to unlock vast quantities of oil from shale formations in places like North Dakota and Texas. It’s hard to overstate the impact of the fracking boom: US crude oil production has nearly doubled since 2010.
Eventually, supply caught up with demand — and then surpassed it. That’s when the crash came.
By mid-2014, global demand was starting to slow down. Europe was still reeling from the eurozone mess. China’s economy was starting to stumble. But the United States continued to produce more and more oil. Iraq and Libya were also starting to bring more production back online. So prices began sliding, down to $70 per barrel.
At that point, many people expected Saudi Arabia and other oil producers in OPEC to cut back on their own production to prop up prices, as they have in the past. (Conventional wisdom had held that Saudi Arabia needed $100 per barrel oil to balance its budget.)
Surprisingly, that didn’t happen. Saudi Arabia decided to increase production in order to maintain its market share, hoping that the subsequent fall in oil prices would crush US frackers, who require higher prices to stay profitable.
And that’s when things got really interesting.
Ever since Saudi Arabia’s decision to maintain output in late 2014, prices have kept tumbling and tumbling — to $50 per barrel, then $40, then $30 — largely because supply has remained strong and demand has been weaker than expected.
US drillers turned out to be far more adaptable to low oil prices than the Saudis thought, as companies cut costs and boosted productivity in order to keep the oil flowing. (US production has finally stopped growing over the last few months, but the decline has been far less severe than originally predicted.) Iraq has nearly doubled production since 2014 — to more than 4 million barrels per day — as it recovers from conflict. Thanks to the nuclear deal with the US, Iran will start exporting more oil this year as sanctions are lifted, offsetting declines elsewhere.
In the meantime, major developing economies like China, Russia, and Brazil remain mired in a slump, putting a damper on oil consumption. An unusually mild winter helped suppress demand for heating oil. And a stronger dollar means that some countries now have to pay more for crude imports, which further limits consumption.
That’s the basic story. As long as supply far outstrips demand, oil prices will stay relatively low.
Cratering prices are having all sorts of ripple effects around the world. Car owners in places like the United States, Europe, Japan, are suddenly paying way less for gasoline, which means they have more money to spend on other things. (Arguably, low prices have helped juice the US economy this past year.) SUVs and gas guzzlers are coming back in style.
On the flip side, crude producers like Saudi Arabia and Russia are struggling to balance their budgets and suffering from a major revenue crunch. Oil companies in the United States and elsewhere are watching profits evaporate. Banks that financed the US shale boom are starting to reel from heavy losses. It’s a big deal all around.
So when will oil prices rise again?
No one knows for sure. Or, if they do, they’re laying bets in the financial markets rather than writing articles about it. Jad Mouawad of the New York Times recently took a look at various forecasts: Some banks project oil prices to keep plummeting down to $20 per barrel this year. Others expect a rebound to around $50 or $60 per barrel by year’s end as the US shale boom tapers off and demand recovers.
In January, the IEA pointed out that prices could easily slide lower this year if Iran ramps up production faster than expected. “In a scenario whereby Iran adds 600 kb/d to the market by mid-year and other members maintain current output, global oil supply could exceed demand by 1.5 mb/d in the first half of 2016.… So the answer to our question is an emphatic yes. It could go lower.”
Ultimately, the supply and demand dynamic is the thing to keep an eye on. And expectations matter a lot here. Whenever new data shows an unexpected boost in oil production or an unexpected drop in oil demand, prices tend to go down. Conversely, a surprise drop in supply or a surprise surge in demand will push prices back up.
So if, say, the cold war between Saudi Arabia and Iran heats up and somehow leads to disruptions that crimp production, prices could rise. (So far, that hasn’t happened.) If low prices are harder for the US shale industry to handle than anyone thought, that could cause prices to rise even higher. If China’s economy suddenly rebounds unexpectedly, that could have a similar effect. Or maybe Iran will do something that causes EU and US oil sanctions to snap back into place. Alternatively, perhaps the supply glut — and hence low prices — will persist indefinitely. It’s a guessing game, and there are lots of plausible guesses.
* Note: Under the IEA’s definition, “oil supply” includes crude oil, condensates, natural gas liquids, refinery products, as well as biofuels. This is currently around 96 million barrels per day. Crude oil and condensates are the largest portion of this supply, coming in a bit under 80 million barrels per day.
A look at how the US shale industry has managed to keep drilling in the face of low oil prices (at least so far)
What the Iran nuclear deal means for oil prices
Saudi Arabia’s latest panicky move: a possible IPO of its state-owned oil company
Our 2014 explainer on the oil price crash
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