Lower Oil Prices are Here to Stay

When oil prices fell sharply in the middle part of last year, many experts believed that this would be just a short-lived downturn, with oil prices likely to return to their high levels in short order.  However, this decline in oil prices has proven not only to be anything but short-lived, but oil prices have actually fallen further in recent weeks.  Moreover, an increasing number of economists are convinced that lower oil price levels are here to stay for the foreseeable future and many of the leading players in the global oil and gas industry are now preparing for these lower prices to remain in place in the coming years.  For those who orchestrated the decline in oil prices over the past year, most notably Saudi Arabia, the potential for a longer period of depressed oil prices means that their efforts to reduce prices in order to harm their competitors is likely to backfire.

After peaking at $105 per barrel (West Texas Intermediate) and $112 per barrel (Brent) in June 2014, oil prices have fallen in spurts over the past 14 months and are now almost 60% below their 2014 highs.  This sharp decline in oil prices is due primarily to the fact that the supply of oil on the global market has risen significantly over the past year.  Part of this increase in the supply of oil is the result of the massive expansion of the shale oil industry in the United States, which has added a major new source of oil to the world market.  However, it was Saudi Arabia that actually pushed oil supplies to levels that were enough to place great downwards pressure on the price of oil, as the Saudi government hoped to damage both its economic rivals (namely the US shale oil industry) and its political rivals (notably Iran).  With so much oil on the market at a time when economic growth has remained sluggish, it was inevitable that oil prices would fall as sharply as they have done over the past 14 months.

It is not only the supply side that has driven oil prices downwards, but also the demand side.  It had been expected that demand for oil in China and other large emerging markets would continue to grow rapidly, but instead, economic slowdowns in Asia, Latin America and elsewhere have dampened demand for oil in these once-high-growth markets.  Moreover, demand for oil in the developed world has also not met expectations as the economic recovery in these markets has proven to be relatively weak and as efforts to reduce oil and gas consumption have been increased.  As a result, while record levels of oil are entering the market, the demand for oil is not rising as fast as had been hoped and this is leading to lower price levels than had been expected just a short time ago.

Looking ahead, this imbalance between the supply of oil and the demand for oil is likely to remain in place for the next few years.  Saudi Arabia’s efforts to weaken the shale oil industry in the United States have largely failed, as production in the US remains high, despite the loss of profitability for many shale oil operations in that country.  Furthermore, Saudi Arabia’s efforts to further weaken its great political rival, Iran, are in jeopardy of collapsing as the recent nuclear deal with Iran will allow Iran to once again export its oil around the world, further adding to the already excessive global supply of oil.  On the demand side, economic growth in China is likely to slow further in the coming years, while the outlook for many other large oil markets is mixed as the global economy is settling into a prolonged period of marginal growth.  As a result, without any major external shocks, low oil prices appear to be here to stay for the foreseeable future and this will have a major impact on many of the leading players in the global oil industry.