What are the main causes of the long run dramatic drop in oil prices?

July 05, 2016 2 min read

By James Weston, Chatham and Clarendon House Grammar School, Alumnus of The Young Investment Banker Programme 2016

In recent months the price of oil has plummeted, both Brent and WTI fell from $155 per barrel in June 2014 to $35 per barrel at the start of 2016, this has been the worst downturn in the industry since the 1990s. The market forces of supply and demand are to blame, with both an increase in global supply and a decrease in demand leading to the subsequent price fall.

The supply side

Saudi Arabia, the most prolific oil exporter, is arguably the most influential of the 12 biggest oil exporting countries which make up the Organization of Petroleum Exporting Countries (O.P.E.C), and is seemingly responsible for the supply side issues leading to the price fall. The nation raised its exports of the commodity by 3.5% from the first quarter of 2015 to the first quarter of 2016. There are numerous theories as to why this was implemented, one being to damage Iran’s economy with whom it has religious conflicts. It is also arguable that Saudi Arabia has incentives to gain advantages over US oil producers within the market as low oil prices may have been executed to cause bankruptcies of high cost US producers.

But the biggest and most widely accepted reason is due to the intentions of the new oil minister of Saudi Arabia, Khalid al-Falih who imposed the price fall. He made a statement during June 2016 in the latest O.P.E.C meeting that a fall in the oil price would reduce the country’s dependence on oil. He felt that this would stimulate economic growth for Saudi Arabia as it would allow it to venture into other industries such as electricity and renewable energy. Mohammad bin Salman bin Abdulaziz Al-Saud, Saudi Arabia’s Chairman of the Council of Economic and Development Affairs has been given the task by the ministers of Saudi Arabia to oversee Vision 2030-a strategy for al-Falih’s proposed economic growth. The policy aims to create 6 million new Saudi jobs and double the size of the economy, which is to be achieved through low oil prices.

The demand side

Low economic activity throughout the world and more energy efficient vehicles are the general demand side reasons why the price of oil has fallen. However, as the world’s second largest economy, China is the culprit. It has experienced fierce slowdown, having to cut its growth target to a 20-year low of 7%. China’s record debts are to blame for this as they have led to reduced spending and aggregate demand. The debts account for a substantial 250% of the country’s GDP which includes government, corporate and household borrowings.

Overall, evidence suggests that the decline in oil prices is mainly led by supply side issues. However, from a personal perspective I believe that both supply and demand make up equal parts of the picture as supply and demand for the commodity are interdependent.

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