It is textbook economics: falling demand and rising supply.
Why is the oil price falling?
The US has ramped up domestic oil production by investing in fracking projects. US oil production increased by around 48% between 2008-13, taking output to 11m barrels a day by early 2014. At first, the US surge in output was offset by supply disruptions elsewhere: western sanctions on Iran, turmoil in Iraq and Libya. But some supply problems have abated.
Just as supply has peaked, demand for oil has been slowing. Consumption in Europe and Japan fell in 2014, as governments struggled to fix economic problems. In the US, tighter fuel economy standards for vehicles and the closure of petrochemical plants led to a reduction in demand. Perhaps the biggest factor weighing on oil prices was a slowdown in the Chinese economy. These big trends hit home in 2014. Prices dropped by more than a third over last summer and autumn. When the Opec cartel announced in November it would not cut production in response to falling prices, it caused a further drop.
How much further can oil prices fall?
The US government expects that Brent crude will average $68 a barrel in 2015. Some traders are making bets on oil falling to $40 or $30, with a few putting money on $20 – a level not seen since 2002. Stephen Schork, a US-based market analyst, said investor “psychology” is driving oil trading. “We could get a rebound to $70 but we could see $30 before we see $70.”
So is this good news for the economy?
There will be winners and losers, but economists are divided on the overall impact. Falling oil prices could be “a shot in the arm” for the global economy, according to the International Monetary Fund. The fund estimates the recent drop in oil prices could add up to 0.7% to global economic output in 2015.
But not everyone is convinced. Falling oil prices have coincided with a sharp appreciation in the dollar, which is a growing economic headache for many emerging economies, such as China and Brazil, while Russia has been hit hard due to its dependence on oil revenues.
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