A Look At Why Crude Oil Prices Keep Falling: IEA Report

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In June 2014 a barrel of WTI Crude fetched $100, by early 2015 that price had already dropped to $55, and that same barrel price is now hovering around $27. At its core the reason is simple, the world produces far more oil than is needed, about 1.5 million barrels more.

The International Energy Agency (IEA) expects this to remain the case throughout 2016 and unless something changes, the oil market could drown in over-supply. This is a big change from 2010 to 2014 because oil demand was a lot higher with production trying to keep up as older oil fields were stagnating and conflicts in Libya and Iraq were restricting supply.

Source: IEA

Source: IEA

As prices jumped to about $100 per barrel, drillers in the US using new horizontal drilling and hydraulic fracking techniques started the fracking boom and US crude oil production has doubled as a result since 2010.

Supply caught up with demand and surpassed it, but then by mid-2014 global demand started slowing down, the Eurozone was a mess, and the Chinese economy was stumbling. Consequently, US oil production kept increasing and the oil fields in Libya and Iraq came back online, so prices started sliding to about $70 per barrel.

It was expected that top OPEC oil producers like Saudi Arabia would start cutting production to keep the prices high, but that didn’t happen. Instead, Saudi Arabia increased its production to maintain its market share while hoping to run US frackers out of the market at the same time. Ever since then the price per barrel has been dropping as supply stayed strong and demand was weaker than expected.

US frackers turned out to be far more nimble than expected as they cut costs and increased production. Even now as US oil production is declining that decline is far less than predicted. Since 2014, Iraq has also doubled production while developing economies like Russia, China and Brazil are still in a slump dampening oil consumption and demand. There was an unusually mild winter and the strong dollar has further limited oil consumption because countries now have to pay more for crude imports.

The low crude price has all kinds of interesting effects across the world. Gas prices are lower which means car owners have more money to spend on other things, while SUVs and other gas guzzlers are making a comeback, especially in the US. On the other hand, countries like Russia and Saudi Arabia have trouble balancing their budgets, oil producers in the US see their profits disappear and the banks that financed the fracking boom are starting to sustain heavy losses. Nobody really knows when it will end. Some banks brace for oil to drop to $20 per barrel in 2016 while others expect a rebound to about $50 or $60 if the fracking boom tapers off and demand recovers.

Since international sanctions against Iran were lifted, more oil is yet expected to hit the market. The IEA warned that if Iran manages to increase its production faster than anticipated, it could cause oil to drop even more as global supply keeps outpacing demand.

Any disruption in production could drive prices up again. Whether that is the Chinese economy recovering, the US fracking industry stumbling even more, increased tensions between Iran and Saudi Arabia or sanctions against Iran being restored. All these scenarios could make oil prices jump higher, but the supply glut could remain, and low prices could be with us for the foreseeable future. In the end, anybody’s guess is as good as another.

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