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Oil: Past, Present and Future

 3 min read / 

The rapid decrease of global oil prices has been a matter of critical discussion in the economic world. Falling by over 50% in the past year, the price of Brent crude per barrel reached a 6 year low on Friday 29th January. But what are the reasons behind this fall? What are its effects on the economy? And lastly, what is in plan for the upcoming future?

There are three main reasons for the plunge in prices, two regarding increases in supply and one lack of demand for the commodity. Firstly, the markets have witnessed a sharp increase of the US oil production, which is still expected to rise in 2015 to about 9.3 million barrels per day, following the discovery of the extraction method of “fracking”, which has led many new companies to enter the market, says Russ Koestereich, Blackrock’s Managing Director and Chief Investment Strategist. Secondly, there has been resilience from OPEC’s main players, including Saudi Arabia, to cut supply, possibly in order to drive the new US entrants out of the market, as Saudi Arabia is able to sustain an environment of lower prices yet still be profitable unlike its US counterparts, which have higher extraction costs. Finally, low inflation and minimal growth in Europe coupled with slowing growth in China has led to a plunge in the demand for the commodity, and this mix of high supply and low demand has eventually caused the prices to tumble.

Regarding the impact on the global economy, the plunge has created a number of losers and winners. The former include the majority of the population, as a reduction of oil prices works as a tax cut, increasing the disposable income of the average person. Furthermore, it has helped transport companies such as airlines by significantly lowering operating costs, as well as the retail sector of the economy, as transportation costs are drastically lowered. However, others were not as lucky. BP PLC reported a replacement cost loss of $969 million for the fourth quarter of 2014, after reporting a profit of $1.51 billion in the same time frame last year. And it is not the only one with such high losses as other energy companies have been facing the same problems. Additionally, countries such as Russia and Venezuela have been hit hard. Both countries’ credit rating has been downgraded to junk by Standard & Poor’s, worsening their already precarious situations.

Ultimately, the future seems uncertain, characterised by high volatility in oil prices, mainly as a result of countries’ specific risks such as the threat of terrorist attacks by ISIS in the Kurd region of Iraq where most of the country’s oil production is located. Furthermore, it seems that present prices are unlikely to lead to an instantaneous decrease in US shale production. However, many oil firms are cutting their investment budgets, which will negatively impact their long-term competitiveness, thus increasing the prospects of a future with fewer producers, in which case an eventual cut in supply will lead to sky-rocketing prices. As to whether the prices have reached a bottom line – this is the topic of much debate. For now, all we can do is wait and see.

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