Why are oil prices falling?

Global oil prices are seeing a decline in the recent past. For nearly five years we had the global crude oil price at over $ 100 a barrel. In fact June 2013 saw a record price of nearly $115 a barrel so which when compared to recent prices of $83-85 a barrel is a significant 25% drop. Oil companies expecting demand from growing economies in India, China and other Asian countries have been increasing their production capabilities. These production facilities like the artic drilling platform is not sustainable if the price fall below $ 90 a barrel. The current prices at close to $ 80 clearly indicate the clear driver of these prices is the US. The other two reasons is over supply and weakening demand.

Over supply

The case of US

President Obama had said in 2012 “the problem is we use more than 20 percent of the world’s oil and we only have 2 percent of the world’s proven oil reserves.”. Ironically, The US oil production is increasing year on year. At the end of 2008, US extracted 9.1 Million barrels of oil/day which then was close to 10% of the global production (84.9MBarrel/day) and at the end of 2013 US oil production accounts for nearly 14% of the global oil production by producing 12.3Million barrels/day. This is a metronomic rise which raises on question as to when US will replace middle east and Saudi Arabia as the global leader in oil production. USA was the largest producer of oil at one point of time, but its industrial growth coincided with the decline in oil production which lead to its dependency on the middle east for economic sustenance. However, ‘shale gas’ exploration since 2008 have produced great results, new fields are being explored in states which had run out of oil. Technologies like horizontal drilling and hydraulic fracturing are just in nascent stages of development but already that has enabled US to claim the No 1 spot for production of natural gas. The development of this sector can’t be ignored because it has created jobs for close to 100000 people whereas other industries cumulatively have lost jobs by the same number since the recession of 2008.

On the other side of the planet, Saudi Arabia is enjoying what typically is called ‘peak oil’. Iran has also seen a rise in oil production and the other partner in OPEC , Venezuela has long flexed its arms for being a significant oil producer in the Americas. Russia which had seen a decline since dis integration has been on the rise, its production of 9.9Million barrels a day has risen to 10.5 Million barrels a day in 2013. Over supply is further complicated by an increase in oil production in Libya.

Weakening demand

Oil prices right throughout the history have been linked to the US production and consumption patterns. In 2010, world total primary energy consumption was 511 quadrillion Btu. The United States’ primary energy consumption was nearly 98 quadrillion Btu, nearly 19% of world total primary energy consumption. Significantly the primary total energy consumption has been declining in the US since 2010 and its assumed to further decline a 2% year on year. Thanks to a rise in local production, the imports of oil have been going down, from 2.5 Million barrels a day in 2011 it dropped to 2 Million barrels a day in 2012. That brings to mind a graph that traces US’s domestic energy production as a percentage of consumption.

Domestic energy production had dropped to nearly 70% in 2005 but has risen above 80% in 2013.

Looking at the demand of other countries, China which was having a growth rate of 9% a year ago recently predicted a 2% drop in this year’s growth numbers which analytically can be comprehended with a 2% less demand for oil and energy supplies. Europe has also seen a slow economy and Japan which has seen an influx of renewables, coal and natural gas has been reducing its dependency on oil which will be further reduced next year when their nuclear plants are expected to be operational. The International Energy Agency in its October release has lowered the 2015 oil requirement by 300,000 barrels a day. In fact Saudi Arabia had cut daily production by that number in the last few months due to poor demand. The demand for oil is declining globally which has resulted in the major oil producers to cut their prices in order to compete in a shrinking market, i.e. the world minus the US.

There are other cause and effects to this scenario, Venezuela for instance will cease to yield its dominance. Russia, Iran (already on sanctions for their nuclear policies) and even Libya which has seen a rise in oil production after all the turmoil will see a decline in profits owing to lower prices. Few pundits in fact correlate the current situation to the 1990’s where lower prices resulted in fewer development projects which in turn couldn’t supply the demand of early 2000s’ thereby raising the prices to over $ 100 a barrel. They substantiate this theory with the heavy investment by oil/energy companies in US, artic and other regions to discover new fields and new technologies, which wouldn’t have been the case if the oil prices dint cross the $ 100 mark. And looking at the past few months we don’t see that happening and US is bound to continue the bull run in fracking which means Mr. President was wrong when he said “Even if we drilled every square inch of this country right now, we’d still have to rely disproportionately on other countries for their oil.”

Source of Stats: International Energy Statistics