Oil prices at $50: Why a barrel of crude costs less than your shoes

Oil prices briefly dropped below $50 a barrel Monday for the first time in five and a half years. What's driving the oil prices plunge, and how long will it last?

Got $50? Now you too can take home a brand new barrel of crude oil.

In energy markets, 2015 isn't proving to be very different from 2014. Oil prices have continued their slide, briefly breaking the $50 per barrel mark on Monday. The last time that happened was the spring of 2009, when the global economy was reeling from the Great Recession. Just six months ago, oil prices were double what they are today. Most forecasts suggest they will continue to drop further into the $40 range, or even lower. Gas stations all across the country are selling gasoline at levels not seen in five or more years.

What's going on here?

At its simplest, the oil crash is a matter of too much supply and not enough demand. The US is pumping massive amounts of new oil, and volatile Middle Eastern producers are maintaining or even expanding output despite regional turmoil. The Organization of Petroleum Exporting Countries (OPEC) would normally cut production to boost prices, but the cartel is sticking with its production levels to preserve its share of the global market.

Meanwhile, demand is flat in the US and Europe, where energy efficient technologies and alternative fuels are displacing the need for oil. Also, China, India, and other industrializing nations aren't growing as quickly as expected, and that's putting downward pressure on prices.

Is this a good thing or bad thing? 

Depends on whom you ask. If you're a major oil consumer like the US, Europe, or China, it's mostly a good thing. Americans saved about $14 billion on gasoline this year compared to 2013, according to AAA, the Florida-based automotive group. Overall, world GDP should grow between 0.3 and 0.7 percent in 2015, according to the International Monetary Fund, compared to a scenario without the drop in oil prices.  

 

"Overall, lower oil prices due to supply shifts are good news for the global economy, obviously with major distribution effects between oil importers and oil exporters," IMF economists wrote in a blog post late last month. 

If, however, you are a major oil producer, crude at $50 is not so pleasant. Petro states like Russia, Iran, Venezuela, Nigeria, and others depend on the revenue they generate from selling oil to customers abroad. A 50 percent price drop in those countries hurts a lot, particularly when the cost of extracting those barrels is generally increasing. As the easy-to-reach oil runs out, producers are forced to explore in more far-flung, more expensive locales (think the Arctic, ultra-deepwater offshore). Even US production, which relies largely on extracting from expensive shale formations, is at risk from the rapid devaluation of oil. 

Should a rapid plunge persist, it could have broader negative consequences for the economy as the effects ripple through other sectors. Alternative fuels and the climate are also vulnerable to cheap fossil fuels. For instance, sales of gas-guzzling SUVs and large pickup trucks surged last month, as cheap gas made fuel efficiency less of a priority for consumers. 

How long will cheap oil last?

Energy markets are notoriously difficult to predict, but most analysts don't expect a major rebound in oil prices anytime soon. Reports of historic production levels from Russia and Iraq are the latest news driving down prices. US crude was trading at about $50.54 a barrel late Monday, after briefly touching $49.95 earlier in the day. Brent crude, which typically trades a bit higher, hovered around $53 throughout the day. There's not much on the horizon that analysts think could send markets in the opposite direction, and many believe prices should fall further into the $40 range and perhaps even lower.

"There's no doubt that we have a combination of supplies hitting their zenith at a time when demand is weakening," Phil Flynn, analyst at Price Futures Group in Chicago, told Reuters.

Still, anything can (and does) happen. A terrorist attack could suddenly disrupt output in a major producer like Libya and stop or even reverse the downward trend in oil prices. Or OPEC could call an emergency meeting and decide they are finally going to cut production and ease the supply glut. Eventually, most analysts expect global demand will pick up again just as producers are cutting back, which would reverse the market fundamentals and drive prices back up again.

But, for now at least, the world has awakened to oil's new reality, and much of 2015 will be spent making sense of it all.