Fall in Global Oil Prices: Reasons and Implications

In last one and half year, the Global oil prices have fallen sharply. From 2010 till mid of 2014, the oil prices were fairly stable above $100 per barrel, however, currently the prices are below $50 per barrel.

Reasons

There are several reasons for this decline. Firstly, the demand is low because of weak economic activity, increased efficiency, and a growing switch away from oil to other fuels.  Secondly, turmoil in Iraq and Libya—two big oil producers with nearly 4m barrels a day combined—has not affected their output; thirdly, USA has become the world’s largest oil producer. Though it does not export crude oil, it now imports much less,  creating a lot of spare supply. Fourthly, the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price.

Falling demand and US Shale Gas Boom

The high prices provided incentives for drilling and exploration in unconventional areas such as exploration of Arctic region by Russia, exploration of shale gas by USA in North Dakota. United States and Canada entered into the shale gas boom after they successfully developed the fracturing and horizontal drilling techniques. Further, United States also skyrocketed its  domestic production of oil, which led it to get the first place among all oil producing countries. The increased domestic production of oil and shale gas exploration from Alberta and North Dakota eased United States demand from Middle East. Since demand was lost, price came down beyond the capability of OPEC to hold it. International demand of oil also reduced in China due to its domestic production as well as recession in economy.

Turmoil in Middle East

Despite the shale gas boom in US, the prices of oil did not fall considerably because of OPEC induced cut in oil production and supplies. However, from mid of 2014 onwards, the Libyan rebels opened two terminals for export of oil.

Further, this was probably for the first time that there was no consensus among the OPEC countries to decrease the supply because of fear of losing market share. Thus, supply did not fall while demand went down causing prices to go down. We note here that OPEC countries including Saudi Arabia could curb production sharply to correct the prices. But they know that benefit of this would easily pass on to countries they detest such as Iran, Russia etc. With over USD 900 Billion in reserves, Saudi has the capability to tolerate lower oil prices quite easily. It has $900 billion in reserves. Further, its own cost of production of oil is very less.

Increasing share of renewable energy

In recent years, there has been a continuous increase in the share of the renewable energy around the world. This is supplemented with the development of efficient solar PVs and continuous fall in their prices.

Implications

On oil exporting countries

For the countries that produce oil, the fall in prices has led to huge loss of revenue. Further, the lack of coordinated action from OPEC countries has exposed their own vulnerability. OPEC has already lost its dominance on oil price scenario and some countries such as Saudi Arabia have not stood with this group in the fear of loss of market share. The impact on Venezuela can be see reeling under high inflation. Russia, whose 70% export income came from oil exports is hit hard with changing oil economics. The countries which don’t have sufficient foreign exchange reserves such as Iran, Iraq and Nigeria are among the worst hit.

Oil Importing Countries

Countries such as India have traditionally paid huge import bills. They have been able to decrease their fiscal deficit to great extent. After deregulation of petrol, there was a fall in prices because petrol prices are now linked with market. China, Japan, India have benefits because of low oil prices.

Impact on environment

The impact on environment should be seen in conjunction with the below three factors:

• The share of fossil fuels in the total power sector is decreasing since 1970 due to increasing share of renewable energy around the globe.
• Due to falling oil prices, there may be an increase in consumption due to availability of fuel at low prices.
• However, since prices are low, the exploration in new and unconventional areas gets discouraged.

In summary, the impact of lowering prices of oil have both negative and positive impacts on environment.

Future perspective

The prices of oil seem to be low in near future. However, any decrease in supply, further conflicts in Middle East, increased demand in Europe / China might cause the prices to jump.