Increased Oil Production results in lower prices at the pump

The plummeting price of oil is the biggest energy story in the world right now. The results are cheap gasoline for the United States while not as good news for mostly oil producing economies like Russia and Venezuela.

In June, the price of Brent crude was up around $115 per barrel, by mid-December, it had fallen nearly in half, down to $59 per barrel.

For much of the past decade, oil prices were high — bouncing around $100 per barrel since 2010 —because of soaring oil consumption in countries like China and conflicts in key oil nations like Libya. Oil production couldn't keep up with demand, so prices spiked.

BY 2014, OIL SUPPLY WAS MUCH HIGHER THAN DEMAND

But beneath the surface, many of those dynamics were rapidly shifting. High prices spurred companies in America and Canada to drill for new, hard-to-extract crude in North Dakota's shale formations and Alberta's oil sands. At the same time, demand for oil in places like Europe, Asia, and the US began tapering off, thanks to weakening economies and new efficiency measures. Not only that, the conflict in Libya was slowly easing.

By late 2014, the world’s oil supply was on pace to surpass demand, and by September prices started falling sharply.

As prices fell, many experts waited to see what OPEC would do. OPEN is the largest oil cartel in the world. Would they reduce production to prop prices up (as many OPEC nations like Saudi Arabia and Iran need higher prices to balance budgets)? However at the November conference OPEC did nothing. Saudi Arabia wanted to retain market share. As a result oil prices went into free-fall.

Lower prices are good news for consumers, especially in Japan and the United States. Contrast for some countries, it’s bad news for nations like Russia and Venezuela who are more reliant on oil sales.

This led to a boom in "tight oil" production. The US alone has added about four million new barrels of crude oil per day to the global market since 2008.

Up until very recently, however, that US oil boom had surprisingly little effect on global prices. That's because, at the exact same time, geopolitical conflicts were flaring up in key oil regions. There was a civil war in Libya. Iraq was a mess. The US and EU slapped oil sanctions on Iran and pinched its oil exports. Those conflicts took more than 3 million barrels per day off the market:

Even more significantly, oil demand in Asia and Europe are weakening — particularly thanks to slowdowns in China’s and Germany’s economies. More broadly, oil demand has been stagnating around the world. The United States, once the world's biggest oil consumer, saw big cutbacks in industrial oil use after the recession, while gasoline consumption has flatlined as fuel-efficient cars became more widespread. At the same time, countries like Indonesia and Iran have been cutting back on fuel subsidies.

That brings us to OPEC, a collection of oil-producing nations that pumps out about 40% of the world's oil. In the past, this cartel has tried to influence the price of oil by coordinating with other members.

At the meeting in Vienna on November 27, there was much intense debate among OPEC members about how best to respond to the drop in oil prices. Some countries, like Venezuela and Iran, wanted the cartel (mainly Saudi Arabia) to cut back on production in order to prop up the price. These countries need high prices in order to "break even" on their budgets and pay for all the government spending they've racked up:

On the other side of the debate was Saudi Arabia, the world's largest oil producer, which was opposed to cutting production and willing to let prices keep dropping.

SAUDI ARABIA IN FAVOR OF LETTING PRICES CONTINUE TO FALL

"We will produce 30 million barrels a day for the next 6 months, and we will watch to see how the market behaves," said OPEC Secretary-General Abdalla El-Badri at the November meeting..

As of now it’s fair to say that OPEC is engaged in a "price war" with the United States. This could result in it being more expensive to extract shale oil from formations in places like Texas and North Dakota. So Saudi Arabia and others are betting that as long as the price of oil keeps falling, some US producers may become unprofitable and may go out of business, and thus the price of oil will stabilize.

A big question: Will low oil prices kill the US shale boom?

Nobody quite knows the answer to this question. How low prices need to go to rein in the US oil boom? Analysts often focus on a metric called the "breakeven price" for oil-drilling projects. This is in light of the U.S. Energy Information Administration that expects overall U.S. oil production to grow another 700,000 barrels per day.

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By Bryan Gray | | Gas Prices, Natural Gas, Petroleum | 0 comments
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