So in the past year, oil has dropped 49%, which is the second biggest fall since inception. The question is why?
The oil price is mainly determined by supply and demand dynamics, and with a slow down in Europe and China, this would explain the demand, but surely this could be countered by OPEC cutting supply, and driving the oil price higher? This would be basic Economics 101! Another reason could be the political unrest in the Middle East? This should not have that big an effect on the price, as they only make up one third of the OPEC production. What about the big move to alternative energy sources?
All of these may be a factor as to why, but one of the main reasons the price is falling, and may continue to fall are the internal arguments in the oil cartel! OPEC or better yet, Saudi Arabia could bump the price of oil back to $90 per barrel, but why? Saudi Arabia has the lowest cost to produce oil in the world. At a cost of $5-$6 per barrel to produce, they are still making 900% profit! So why not get the price higher and make more profit you ask? Well simply put, the U.S. needs a higher crude price to drive the technology advancements in fracking and shale oil, and to potentially move fracking to other countries. Currently, the U.S. is the only country with successful fracking operations. There is also a big drive to hybrid transportation. With a lower oil price, and ultimately a lower petrol price, why would you trade in your V8 Mustang for a Nissan Leaf? If you make petrol more affordable, you make the end user of petrol more likely to keep his gas-guzzler. This in turn means the consumer has more money at the end of the month due to lower expenses on gas, driving consumer spend in other areas. Which, once again is supply and demand!
The bottom line is that the Cartel is at a crossroad. There are views that Saudi Arabia is trying to cripple the U.S. Shale industry, while others say they just pulling a raspberry at Iran and Russia.
The question then must be where to next for the oil price? It would be easy to assume that the oil price may continue to fall to around $30 per barrel, based on the fact that Saudi Arabia seems to be driving the price down, and they still making profit at $10 per barrel, but realistically, even Saudi Arabia needs the price of oil higher! Making profit is one thing, but driving an economy is another. Saudi Arabia relies so heavily on the oil price to sustain GDP, that it would need the oil price above $90 to keep its GDP healthy. This current flooding of oil into the market will have short-term effects on the oil price, but its other factors that will determine the long-term price. We may see lower prices over the next 6 months to a year, but even when Brent crude hit its low of $04 in 2008, it didn’t remain there for long, and 3 years later it was back over $100 per barrel, a 200% increase.