Crude oil prices have hit their lowest in years this month, and prices just keep dropping.
Why? Look no further than weak demand and a glut of supply. Crude oil markets are notoriously bad at balancing the two, says Deborah Gordon, director of the energy and climate program at the Carnegie Endowment for International Peace, a Washington-based think tank. And now there’s more oil than the market knows what to do with.
“The best markets find equilibrium between supply and demand,” says Ms. Gordon. “But oil is an imperfect market in almost every way.”
The global crude oil marketplace is riddled with government intervention, cartel power-brokering, high capital costs, and imperfect information on oil production. Those factors conspire to make it a difficult market to predict or control, Gordon says, adding that “it would be hard to create a more imperfect market.”
On the supply side, US oil output is expected to pick up even more in November, with producers extracting 118,000 additional barrels per day, bringing US production to 5.14 million barrels a day, according to a US Energy Information Agency report released Tuesday. Meanwhile, Libyan oil has shakily re-entered the global market, and the Organization of Petroleum Exporting Countries (OPEC) has posted the highest output in years.
But booming oil production comes at a time when demand for oil is slackening in Europe and Asia. Austerity and weak consumption in the eurozone are curbing European demand, while currency depreciation and cuts to fuel subsidies are weakening Asia’s thirst for oil.
When you combine lower demand with a glut of oil produced, it’s a recipe for low prices.
US crude slid below $82 per barrel Tuesday, while Brent – the global benchmark – fell to $85 a barrel. After floating around $100 a barrel from 2011 onward, crude prices have fallen around 20 percent since June. And analysts think prices could continue to plunge.
That’s a blessing for consumers, who stand to gain from lower gas prices at the pump. But for countries like Saudi Arabia and Russia, who rely on oil revenues to fill their coffers, low prices could mean government budget shortfalls.
It’s hard to tell how long oil prices will stay low, and it’s just as tricky to predict where they’ll head next. Prices will depend heavily on the prices at which OPEC nations like Saudi Arabia and Venezuela choose to sell their oil.
OPEC controls about a third of global oil supply, and members rely on crude revenues to fund their budgets.
To hold market share as oil prices have dipped worldwide, Saudi Arabia cut its prices in early October. The move signals Saudi Arabia’s willingness to take a lower price for its crude in the short term to prevent investment in US shale and deepwater drilling.
Venezuela, another major producer, would prefer to keep prices higher.
“It doesn't suit anyone to have a price war, for the price to fall below $100 a barrel,” Venezuelan Foreign Minister Rafael Ramirez told Reuters.
OPEC will meet on November 27 to discuss oil output and other cartel agreements.
In the meantime, US consumers are benefiting. Low crude prices drove down gasoline prices to $3.18 a gallon Wednesday – the lowest price since February of 2011, according to Michael Green, a spokesperson from automotive group AAA. The end of the summer driving season is partially to thank for price breaks at the pump, but it’s not the whole story, Mr. Green says.
“We’re seeing something different,” Green says in a telephone interview Wednesday. “What we’re seeing right now are very steep drops in the price of gasoline that are coming on top of similarly steep declines in the price of crude oil.”
Nations that are net oil importers also stand to gain if Saudi Arabia lowers prices to keep market share.
“Saudi Arabia pushing prices down helps China and the EU recover,” Gordon says, noting that much of the world economy is still emerging from recession. And lower prices help reboot demand, driving up prices over the long-run.
Some worry that low prices (like those Saudi Arabia is allowing) and weak demand could deter investment in the US oil boom as producers stand to earn less per barrel of oil. But shale production can be easily ramped up and down, giving energy firms some flexibility in a volatile global oil market. When prices drop, they can more easily pause production and then resume it once prices rebound.
“This fracked oil boom isn’t highly-capitalized like offshore, or Arctic, or tar sands oil,” Gordon says.