Monday, December 14, 2015

Why Oil Prices Are Spiraling Down

David Milberg - Oil Prices going down

Unlike our experience with many other commodities, we have a close, personal relationship with the price of oil. We may not follow soybean futures, but we deal with the oil market at the pump and when we pay to heat our homes.

As a result, we know that prices have been falling dramatically. The price of a barrel of crude oil has dropped by half since the summer of 2014. According to The New York Times, the average household will save around $750 on gas this year.

While we feel those changes in our wallets, we may not know the reasons behind them. Those reasons are both simple and complex.

On the simple side, we need look no further than to that most basic of economic principles, the law of supply and demand.

Demand has fallen, and it has fallen for two reasons. Economies around the world are relatively weak, and the world has slowly become more energy-efficient.

Supply, on the other hand, has remained strong. The United States, for example, has seen domestic production double over the last six years, resulting in a decline in oil imports that has forced producers like Saudi Arabia, Algeria and Nigeria to compete with other producers for Asian markets. The rest of the world’s major producers, including most of the OPEC nations, have shown little enthusiasm for cutting supplies in order to push prices higher.

If supply and demand is the simple answer, things get more complicated when we look at what’s behind the major producers’ actions, especially as motivations differ from country to country.

Saudi Arabia is an important case in point. It’s not only the world’s largest exporter of oil. It’s also the most influential member of OPEC, where it leads a coalition that has successfully thwarted supply cuts despite the opposition of members including Venezuela, Iran and Algeria.

The Saudis have framed their rationale as an attempt to retain market share, but that may not tell the whole story. They may also be motivated by a desire for stability. The Saudis crowned a new king less than a year ago, and the Middle East is, to say the least, continually unsettled. The Saudis may not see this as a propitious time for major changes on any front.

None of the major producers are able to balance their national budgets with oil prices at current levels, so pressure for supply cuts may well increase, and there is little spare production capacity in the global system. The International Energy Agency does not expect 2016 production to surpass today’s high levels, but it does predict that prices will stay low for the coming year.

David Milberg is a full time investor from NYC.

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