What You Need to Know About Falling Oil Prices

Fuel prices have plummeted recently and don't show any signs of going back up as we step further into the new year. You might be asking yourself why this is happening.

The oil industry seems always to be fluctuating and changing, but this recent downturn is the worst that the industry has seen since the late 1990s, and possibly even earlier than that.

Companies that once made record profits are now struggling to keep the money coming in, leading them to stop production on many of their rigs and sharply cut investments in exploration and oil field development. Several smaller companies have gone completely bankrupt, and almost a quarter of a million workers have lost their jobs.

The cause of this crisis is the plummeting price of a barrel of oil. In the last decade, $90-$100 was the norm for a barrel of oil. Now the price has dropped to around $30 a barrel, with no sign of returning to the previous highs any time in the next year.

Why has the price of oil dropped so much?

Much of the reason boils down to supply and demand. In the United States, oil production is at its highest level in nearly 30 years, thanks to new technologies and techniques like hydraulic fracturing, which has made possible the exploitation of previously inaccessible shale deposits. In addition, U.S. crude oil inventories are higher than they have been in over 80 years.

The global oversupply is caused by surging production in other countries as well. Russia, a major oil exporter, has refused to decrease production to help stabilize prices—likely out of a fear that importing countries would respond by boosting their own production, thereby eliminating the market for Russia’s oil exports. Saudi Arabia, OPEC’s most powerful member nation, also appears determined not to cut production. Similarly, the government of Venezuela, another large oil exporter, has stated it will not end subsidies to oil producers.

Oil production is also set to increase elsewhere. In Iran, years of Western sanctions caused oil production to fall, and also barred the country from obtaining the most current technology and equipment from the Western world. However, these sanctions are now being lifted, and Iran is expected to see a boost in production soon. The country’s oil minister recently told CNN that it aims to increase its current output by 1.5 million barrels by the end of the year. Analysts are more conservative, estimating that Iran will be able to add between 600,000 and 1 million barrels to its current production levels in 2016.

However, there are also signs that production rates are dropping, due to a steep decline in exploration investments. The consulting firm Wood McKenzie identified 68 significant oil and natural gas projects around the globe that held a combined value of $380 billion and represented some 27 billion barrels of oil and equivalent natural gas amounts. These projects have been virtually halted since prices started coming down. In addition, Exxon has reduced its oil drilling budget to a 10-year low and has cut spending by 25% on gas terminals and rig leases. Royal Dutch Shell has backed off of costly exploration projects in Alaska. Oversupply, however, is still a global problem despite these developments.

Coupled with oversupply is weak demand. The economic outlook in Europe, several developing countries, and China is weak. China’s recent devaluation of its currency is a troubling hint that its economic woes may be more serious than many observers believe. In addition, automobiles are becoming more and more efficient, reducing the demand for fuel.

Who benefits from the price plunge?

That question is a bit easier to answer: in the short term, the consumer benefits the most from the price drop. Anyone faced with a daily commute can tell you how much gas prices have fallen. With the most recent decline, average gas prices in the U.S. hovered at $1.82 per gallon as of early February 2016. That amount is $.37 less than the previous average this time last year. Americans can now travel further for fewer dollars.

Who suffers the most from falling oil prices?

Many people might assume that it’s the oil companies taking the biggest hit, but that wouldn’t be completely accurate. For starters, oil-producing countries take an enormous economic hit. Russia, Nigeria, and Venezuela are just a few oil-rich countries that are suffering economic—and as a result, political—hardships due to falling oil prices.

Meanwhile, Chevron, Royal Dutch Shell, and BP have all been forced to make cuts to their payrolls. Despite that, they are still better off than smaller oil and gas producers, many of whom have had to sell off their assets and cut out dividends to investors after significant losses.

Unfortunately for the oil-producing countries and companies hurt by the drop in oil prices, there aren't any signs of recovery any time soon. Some balance could be recovered by 2016, but experts believe it will be marginal at best. 

A Look at the Impact of Falling Oil Prices

Much has been made about the recent drop in oil prices. Many people in the United States thought that they would never see gas below $2 a gallon again. However, gas prices are now well below this benchmark, and they continue to decline.

The national average price for a gallon of gas is $1.88, as of January 19, according to AAA’s Daily Fuel Gauge Report. The figure is down sharply as compared with the last 12 months, although gas prices have been falling for longer than that time.

Effect on Businesses

While consumers may be happy paying less for gas, businesses are feeling the effects in a decidedly less positive manner. The New York Times reports that roughly 250,000 oil workers have been laid off. Two-thirds of oil rigs have been decommissioned, and sales of oil production machines are down sharply.

While these numbers may seem shocking to many, a look at just how much oil prices have fallen shows why businesses in the oil industry have taken a serious hit. According to the New York Times, oil prices have fallen by more than 60% since June 2014. Current prices are at their lowest level in 12 years, in spite of the considerable inflation that has occurred during this time period.

Only a few short years ago, oil prices were $90 or even $100 a barrel. The price for a barrel of crude oil is currently about $28. The precipitous decline was unforeseen by the majority of analysts, as most expected OPEC (Organization of the Petroleum Exporting Countries) and other similar organizations to continue managing the supply of petroleum in such a way that prices remained high.

Too Much Supply

However, these organizations have failed to manage the supply as well as they did in the past. Over the last few years, oil production has risen sharply, particularly in the United States, Canada, and Iraq. Part of this increase in supply can be attributed to the advent of fracking in North America. The increased oil production in Iraq is frequently cited as an effect of the somewhat more stable political situation in that country.

The rise in oil production has begun to tail off, but the available evidence indicates that this will not immediately result in a large decline in oil prices. Stockpiles of petroleum products have increased to such a degree that there is more than enough oil for the long term, according to the New York Times.

Although production has begun to level out, there is further evidence that it will pick up again. New technologies are being developed across the industry, especially with regards to the practice of fracking. Moreover, the Gulf of Mexico and the oceans of Canada are expected to yield a great deal more oil in the future, as many drilling projects progress and new projects begin.

Decreased Demand for Oil

Another important factor in the drop of oil prices is the level of demand. With cars becoming more fuel efficient and the global economy remaining weak, demand is significantly less than had been projected in years past. To put it simply, fewer people are buying cars, and those who are on the road use less gas. The trend of fewer cars being sold is expected to end once the global economy improves. However, the fuel efficiency trend is only expected to accelerate.

Is the decrease in the price of oil good or bad? The answer is that it depends on one’s point of view. As with all major market forces, the effects of the drop in oil prices are widespread and complex.

Positive Aspects of Lower Prices

The positive aspects of the decline in petroleum prices are more visible than are the negative. The drop in gas prices is welcome by most adults in the United States who buy gas on a regular basis. The reduction in heating costs has also been quite noticeable, as many homes in the United States are still heated with oil.

The decrease in gas prices is more helpful to those under the poverty line, as they have roughly the same heating and gas bills as everyone else, but have less income with which to pay these bills. The savings are especially important at a time when food and housing costs have risen sharply.

However, the drop in gas prices has also had negative effects. Countries that depend on oil, such as Venezuela, have been hit very hard. These countries often struggle with issues of poverty and income equality, and they are more affected by a bad economy than rich people. The decline in oil prices may even threaten political stability, if a country that relies on petroleum is forced to make cuts to social programs.