Oil Price – A Conundrum

The oil prices are known to follow the basic principle of economics i.e. of demand and supply. Hence, the volumes of oil (proved and proved+ probable) discovered at a given date, likely duration of achievement of the ‘mid-point’ peak of the oil production in a region are accounted by traders for gauging the potential supplying capacity of a region in a long run.

Image source: Power Turbine Supply

From the demand perspective the oil prices are especially sensitive to the macroeconomic growth indicators of the Brazil, Russia, India and China (BRIC nations), the industrial production performance of the 34 OECD countries and availability of substitute sources of energy with the consumers.

When one looks at the historical movement of the Brent price in the recent past; apart from a sudden fall in the crude prices during the period following the global financial crisis of 2008, the crude prices are seen to maintain at levels in the range of $85-105 per barrel till the last quarter of 2014.

The high levels of oil price between 2009 and 2014 can be attributed to the fast pace of economic development of the BRICS nations especially that of India and China which increased the earning potential of more than one-third of the world’s total population.
Besides, the oil producing nations in order to maintain their margins intact loaded additional costs of drilling onto the delivery price. Another reason for the increased price of crude oil was a prolonged instability in some of the regions in the Middle East and in Africa which are also major suppliers of crude oil.

However from 2014 onwards there was an exponential increase in availability of an alternate source of energy (shale gas/oil) in North America, especially in the USA. This lead to the decline in demand for crude oil. The shale gas as a source of energy is also considered to be less harmful for the environment than the crude oil.

With the change in the energy trade dynamics, the United States became a surplus country in terms of available sources of energy which lead to a sudden plummet in demand for crude and hence the declining trend in the prices followed. Further with the economy of China also showing signs of stagnation there was a decline in demand from the nation. Besides from the start of 2016, all trade sanctions on Iran were also removed.

Such a scenario wherein the demand of crude oil reduced from the importing countries and the supply by the oil producing countries was not curtailed lead to the crude oil price fall to $ 30.7 per barrel in January 2016. The last time crude oil traded at this level was exactly 12 years earlier in January-February 2004.

It is seen that there has been an increasing concern amongst the natives in the United States about the environmental degradation been caused by the fracking process. Hence, the costs of extracting oil from the shale fields is likely to go up considering more stringent regulations to adhere in terms of cleaning up the process leftovers, limit on underground water consumption, etc. Further, with a positive economic growth projected for the developed nations; the demand for more energy imports is expected to get a boost which would mean improved price levels for the oil.

fx street