The Economist explains...
Everything you want to know about falling oil prices.
Why is the oil price falling?
Mostly because of increased supply from America—up by 4m barrels a day since 2009. Although most crude exports are still banned, American imports have plummeted, contributing to a glut on world markets. Other producers have decided not to try to curb their production and keep the price up.
The Organisation of Petroleum Exporting Countries is dominated by Gulf producers, notably Saudi Arabia. They have huge reserves to cushion the impact of low prices. They also hope that the slump will eventually shut down high-cost production, tightening the market again.
Are they right to think that?
Probably not. America’s shale production boom is based on new techniques—fracking and horizontal drilling—and unlike “big oil” involves small companies and small projects. These are flexible, meaning they will quickly respond to any price rise. And they are innovative: huge productivity gains still lie ahead.
What about the other producers?
Other producers such Nigeria and Venezuela are indeed hurting badly. But OPEC solidarity stretches only so far. Russia tried and failed to get OPEC support for a production curb—and is now ramping up its production in the hope of protecting the volume of oil revenues.
Will low prices continue?
It looks like it. Some high-cost production is closing, but once wells are drilled, it usually makes sense to keep pumping, even at a loss. It is better to make a little money rather than none. And the shale revolution is marching on.
How low can the price go?
If your correspondent could forecast that, he would be on a yacht reading The Economist rather than at a desk writing for it. But much below $40 will sharply increase bankruptcies, and the pressure on OPEC to curb production. Cheap energy also leads to higher demand.
What happens next?
The debate about lifting America’s ban on crude exports is firing up. The petrochemical and steel lobbies are fighting a rear-guard action against big oil. America’s domestic crude (light and sweet) is unsuited for the nation’s refineries (configured for sour and heavy imported oil)—but would make a lucrative export.
Who benefits from low prices?
Winners necessarily outnumber losers (imagine a world in which energy was free). Consumers have more cash in their pockets; industry enjoys lower energy costs, makes bigger profits, and pays more taxes. And it is a great time for companies with strong balance-sheets to make acquisitions.
And who suffers?
The oil industry’s immediate reaction is to squeeze costs out of its supply chain. So wages and margins are falling fast. Highly indebted companies are going bust, with knock-on effects on investors. But lower costs help the industry adapt and increase efficiency.