Oil prices dropped by 42% in 2014, and hit a five and a half year low on Monday. Many analysts are projecting that the price of oil is only going to continue to decrease in the near future. This drop in oil prices is having a drastic effect in a multitude of sectors of the economy, all across the world. What is causing oil prices, which have continually risen in the past decade, to suddenly crash? There is not a single source of this crash, but rather a plurality of causes.
Supply: Its simple economics that when supply increases prices will drop, and that is exactly what is happening in the oil market. The constant rise in oil prices since the mid 2000’s has caused a surge in new oil production projects. The United States is one of the leaders in new investment projects, specifically in shale oil. Domestic crude oil production in the United States alone, has grown by 75% over the past five years. Canada and Brazil have also jumped on the oil production bandwagon, increasing their supplies by 42% and 24% respectively. This increase in oil production has literally flooded the market, and is driving down prices.
Demand: A second major reason why oil prices are dropping is simply because there is less demand for oil. The economy is slowing down globally, especially in China, and this is considerably decreasing demand for oil. In an interview, Danny Gabay of Fathom Financial Consulting, stated that the fall in oil prices was “overwhelmingly, predominantly, if not entirely, a demand shock. It’s China slowing down.”
Saudi Arabia: A third reason why oil prices are falling so rapidly is because Saudi Arabia, one of the world’s leaders in both crude oil production and exports, wants them to. Saudi Arabia has a large reserve of savings from past years of oil profits. This coupled with the fact that Saudi Arabia has some of the lowest oil production costs in the world (around $4 to $5 a barrel) will allow the kingdom to withstand this period of low prices, while many other nations will not be able to. The Saudi oil minister Ali Al-Naimi stated in an interview that he believes the drop in oil prices will discourage any future investment in oil projects, and lead to a scaling back of current projects, particularly in Brazil, Russia, and the coast of West Africa. The scaling back of these projects will help oil prices to rise again, while keeping Saudi Arabia on top in terms of oil production and exports.