Causes and Effects of Falling Oil Prices

As of December 1st of last year, the price of oil worldwide had plunged 28% in 2014 alone.  As of the writing of this article, the price has dropped even further.  The current price of oil is now less than $50 a barrel.  Of all the trends economists examined during the economic crisis in 2008, few predicted this.  The massive drop in oil prices has had wide-ranging impacts on the economy—not just in America, but the whole world.  In these articles, we will examine some of the causes and effects of this trend.  The price of oil has broad implications for regional economies such as the Permian Basin in Texas, as well as our domestic economy as a whole.  What precipitated this trend?  How long will it last?  What will its effects be on consumers and businesses?  Only time will tell, of course, but examining our current circumstances and the history of this trend can help us understand how we got here, and what the future might hold.

The price of oil, like almost everything else, is determined by supply and demand—but this only constitutes a part of the equation.  The other part is expectation.  When oil producers believe that prices will remain high, they invest, eventually causing an increase in production which boosts supply.  Low oil prices tend to make investors shy away, keeping prices lower.  OPEC remains an important part in setting the expectations of oil prices, with countries like Saudi Arabia controlling up to 1/3 of the oil produced in the organization.  When combined with the natural spikes in demand that occur during heavy energy-use months and strong economic conditions, a fuller picture of some of the influencing factors which determine price can be seen.

So what is influencing the supply and demand of oil right now?  There are a number of global factors and conditions at work.  While the domestic economy of the USA is picking up, the world economy remains weak.  Consumer nations have also responded to their dependence on oil and the volatile regions where it comes from by creating more fuel efficient vehicles (at this time last year, for example, the global sales of the Toyota Prius topped 6 million units).  While these conditions continue, international oil production remains at a steady rate.  Iraq and Libya are still producing four million barrels of oil a day combined, and Saudi Arabia, who could restore prices by simply curbing their own oil production, is staying the course.  Finally, domestic oil production In the USA has increased dramatically in recent years.  America has become the largest oil producer in the world, and while the US does not yet export crude, it now needs to import far less.

What are the overall effects of this price decline?  For many, it is an economic boon.  It results in lower energy costs and better prices at the pump.  For other sectors, though, the news is not so sweet.  Oil and hydraulic fracturing companies with deep investments in new wells could find returns diminished with lower prices.  This especially affects the US regions where the oil boom is at its highest.

In our next article, we will examine how lower prices are affecting one of the biggest regions for US oil production: the Permian Basin in Texas.