One thing we have learnt this week- why are oil prices so low?

Why are oil prices so low and why are they falling?  This is particularly surprising with so much war in the middle east and tension in the Ukraine.  There is almost no oil coming out of Libya due to its civil war.  There has been huge disruption to the flow of oil from the northern Sunni and Kurdish regions of Iraq, the is continuing trouble in Nigeria, Syrian oil is not leaving the country (if it is produced at all), there is a shaky truce in the Ukraine and there was a recent war between Israel and the Palestinians.  Any one of these events should send the oil price sky high.  They haven’t, after a long period when Brent crude was stable at around $108-110/barrel its now in the low 90’s.  An analyst on the radio suggested last week that oil prices might fall as far as $85. Natural gas prices are also falling.

The first thing to say is this gas and oil prices are still high by historical standards and when Andy and I wrote in our book the days of cheap energy are over we were not exaggerating.  The graph below shows historical adjusted oil prices and the current price is still high by any standard.

oil price chartThe reason for this fall in oil prices could be for two reasons, the first is unconventional shale oil production in the US, the second is increased OPEC production.  The first reason is logically not correct.  Oil production in the US has increased dramatically since 2008 (BP Statistical Review of World Energy 2014) and this has had no discernible effect on the oil price.   At least it has not lowered it, the dramatic fall in energy prices in 2008/9 was due to the global slump.  Oil prices recovered when Quantitative Easing (QE) was used by the US and UK governments and the global economy recovered somewhat and as I wrote above have been remarkably stable until recently (despite an economic slowdown in China and the EU).  QE is still being used in the US.  The reason for decreased oil prices is that Saudi Arabia is pumping more oil.  The questions are why and for how long?  Saudi Arabia is using a lot more oil itself but needs much higher prices than the current oil price since its cash reserves have shrunk.  The reason why Saudi Arabia periodically pumps more oil to lower the price could be they are worried that rocketing prices will lead people to look for alternatives.

My suspicion is that they have both electric cars and oil fracking in their sights.   With an expected huge fall in battery prices over the next few years high oil prices would make electric cars look very viable.  Its also interesting to note that fracking for oil relies on high oil prices, it needs oil prices somewhere in the $80-90 range to be viable.  The question is how low and for how long will the Saudis allow the oil price to go and by doing this how much are they depleting their reserves?  Saudi Arabia will not be able to do this for ever.

Neil

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