The Effects of Falling Oil Prices

The global price of oil has fallen sharply since June, when oil prices hit $115 a barrel. Now, only four months later, the price for a barrel of oil has dropped to $85, and it could keep dropping. Global supply of oil has increased in recent years, especially in countries outside OPEC, which is one reason for the drop in prices. A more concerning reason that could be adding to the lower prices is a global drop in demand, due to slowing economies, which could signal another global economic downturn. Whatever the reasons, the suddenly low oil prices could have huge impacts around the globe, positively or negatively affecting economies that rely on the production or use of oil.

The supply of oil has increased around the globe, in large part due to increased shale oil production in the United States. Other countries have also experienced an oil boom in recent years, such as Canada and Brazil. These increases in supply, along with steady production by OPEC countries, are a major reason for the dropping prices. This could lead to a battle over which countries will cut production first, most notably between the United States and OPEC. Neither the US nor OPEC has signaled any plans to decrease production, as each is waiting to see their competitors’ break-even point. Since oil extraction is expensive, at a certain price, oil producers will have to slow production or risk losses. The break-even point for shale production has not been tested, and if OPEC and US companies continue to hold off production decreases, oil prices will keep dropping.

For certain economies, sustained low oil prices will have a significant impact. Countries such as Nigeria, Russia, and Venezuela rely heavily on oil revenues in their national budgets. Low oil prices have cut these revenues, and unlike Saudi Arabia, these countries do not have the reserves to soften the blow of the decreased revenues. Unless oil prices return to $100 per barrel, these countries could be forced to explore spending cuts to compensate the lack of oil income. In the United States, shale production, which is cheaper than conventional oil drilling, has not yet reached its break-even price, with some speculating that oil prices could drop to $60 before the break-even point would be reached. If this is indeed true, the United States could become much more influential in the oil industry.

As for countries that primarily use oil, the falling oil prices have potential positive and negative effects. In Europe, Japan, and China, lower oil prices could lead to increased consumer spending, which can help spur economic growth. On the other hand, in Japan and Europe especially, the reduced oil prices could lead to further deflation, potentially slowing economic activity. Whatever happens next concerning oil prices is unknown, but the economic impact will be felt around the globe. All major economies rely on oil in some way, and high or low prices will lead to pronounced shifts in economic activity and political power.