“The price has gone down AGAIN?”
“What in the WORLD is happening to oil?”
“I’m really intrigued but can’t be bothered to sit down and watch an hour’s worth of current affairs”
Do any of the above sound like you?
If so, then fear not inquisitive warrior, for I shall explain this economic crisis in the most concise and simplest of terms. After the next 15 minutes (or less, depending on your reading speed), I hope you’ll have a better understanding of what on earth happened to the price of oil.
- Iran Sanctions
Unless you’ve been living in a cave for the better part of 2015, you’d know that Iran’s sanctions have been lifted.
“Okay, so what Sully?”
Well, Iran is home to the second largest oil reserve in the Middle East (Fourth largest in the world). This means that there are now 3 million extra barrels of oil per day in the market, forecasted to possibly grow to almost 4 million barrels per day by January 2017.
- Shale Oil
It’s pretty well known by now that the US has a significant interest in the oil market, and it has maintained this interest for the last couple of decades or so, as shown by various shale oil companies emerging and starting to produce “Shale Oil”(A substitute for crude oil extracted from sedimentary rocks)
If you know a little bit of economics, you’ll know that if the price of a substitute good for a product goes down, the price of that particular product goes down as well.
For example, let’s say hypothetically, if you have Car A which is very unique, very important, and has little to no mainstream substitutes. It sells for a high price for a very long time.
Then, along comes Car B with the exact same features, but only cheaper. Logically, all the consumers flock to Car B as it does the exact same job for a lower price.
Car A is Crude oil in this scenario, while Car B is representative of Shale Oil. (Both are known as substitute goods)
Now, if you know even a bit of Econ 101, you’ll know that if the price of a good goes down, the price of its substitute also inevitably goes down, as the latter starts losing sales to its now lower priced substitute.
This is exactly what has happened with Crude Oil. As Shale came in with a cheaper substitute for Crude Oil, the world’s largest Oil consumer, the United States, recorded trends of people switching from traditional crude oil to home-grown shale oil. This inevitably led to a fall in the price of crude oil.
- Little to no increase in demand
With Shale Oil and Iran’s Crude oil entering the market, the demand of the oil market is still, more or less, the same. People aren’t suddenly demanding millions and millions of extra oil barrels in their daily lives. That type of change would take years, perhaps even decades. So, once again, basic economics tells us that when supply increases in a market with stagnating demand, the price plummets. (Displayed below)
Even China, the world’s second largest oil consumer, is curbing its demand of oil as it predicts it’s economic growth to start diminishing. Moreover, tighter restrictions by the Chinese government on oil consumption will further reduce oil demand, as the government looks to reducing the infamously bad air pollution of China.
My two cents
There are still a million barrels of oil being produced in excess per day, and the number is forecasted to further increase this year. It seems if the current trend continues, the oil market will drown in oversupply and we could see the price falling to $20 or less.
However, a lot of countries depend on oil for their economies, so I am certain that the governments economists will contrive a policy to alter this plummeting price.
And there you have it, you now know more than before about why the oil price acted like it did. And if you already knew all of this, pat yourself on the back for me!