The price of oil

Mikel Aguirre. Professor. IE Business School

14 April 2015

Plummeting oil prices have direct consequences for the whole world, and many underlying reasons.

The price of oil has fallen dramatically since the summer of 2014, impacting significantly on the international economy, and affecting both consumers and producers. Oil remains the major source of energy into the 21st century, and the planet consumes around 92 million barrels a day, equivalent to two liters per inhabitant. This isn’t the first time in recent decades that we have witnessed a similar situation. In 1986, prices fell suddenly after Saudi Arabia decided to boost output to increase its market share, a change in previous policies that tried to keep production down in order to guarantee higher prices.

Between 2005 and 2013, oil demand outstripped supply. But last year, China began to reduce its crude purchases, further slowing demand in the wake of the OECD countries’ five years of cutbacks in response to the economic crisis. On the supply side, Saudi Arabia has decided not to cut production, despite falling prices. Another factor that needs to be taken into account in understanding the situation is the technological revolution in the United States that has seen the growth of hydraulic fracturing, or fracking, which has increased oil supplies there by almost 50 percent since 2010. Finally, it is clear that the rise of the dollar—the currency oil is traded in—hasn’t helped increase consumption.

There are any number of forecasts as to what oil prices will do in the coming months, but most agree that they may recover to around $70, which is far from the prices of last summer. Estimates suggest that low oil prices could boost global economic growth by between 0.3 percent and 0.8 percent. In general, Europe and Asia will see their balance of payments improve, while African producers such as Nigeria, Gabon, or Angola, could face liquidity problems. Meanwhile, the Arab producers, thanks to their massive reserves and low extraction costs, should be able ride things out.

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