What was once considered a rich “pricey” commodity is now dangling between the hinges for a downfall. We have all heard it and seen it -the slashing of oil prices from a drastic $100-something a barrel to almost $30 a barrel. Such a free fall within the last two years only! And, statistically speaking this plunge accounts for more than 70% ever since 2014!

While the household sector is certainly making merry with the cheap oil easily available at their disposal, there is yet another section that fears this as a threat to their survival. Regardless of the sections, the question that’s repeatedly being asked is “what happened to the oil, really?”

The Economics

It’s a classic case of an economic theory of demand and supply. Now, here’s the long-short story of what had really happened.

Until 2008, crude oil has enjoyed royal pricing globally. OPEC (Organization of Petroleum Exporting Countries) especially the Iraq and Saudi Arabia have held a monopoly over the production and supply of oil worldwide. Back in 2000s you had to shell out around $110-130 to buy one barrel of oil from the international markets. That was the case until major economies were stalled by the 2008 global slowdown. The US and the European countries were the worst hit among the many. Similar was the case with the emerging economies such as China and India. Subsequently, the demand for the oil came down drastically. But that quite didn’t affect the OPEC from slashing the productions and monetizing the prices though their exports had some obvious impact.

The turning point was when the United States of America came out with its own plan of drilling oil with a technique called “fracking”.

Fracking or “hydraulic fracturing” is a technique that extracts oil and gas from shell formation. The use of fracking by american companies (non OPEC countries) made America less dependent on the imports hurting conventional oil producers, more so hurting Russia the most.

Mid-2014 marks the evolution of oil glut !

With the US domestic production of oil and gas growing in leaps and bounds, America was no longer dependent on imports for its oil and gas needs. Eventually countries such as Brazil and Russia that heavily relied on their oil exports saw bearish growth. What more, Europe was nestled in the “eurozone” mess. China too started stumbling. This ultimately brought the demand for the oil down. But America, Libya, Iraq, Saudi Arabia and Russia did not deter in cutting down their production. This created additional supply of crude which ultimately led to crashing prices as low as $70 a barrel !

Source: IEA’s Oil Market Report as on 9th February, 2016
Note that “oil supply” includes crude oil and condensates (which account for about 80 million bpd), and also natural gas liquids, refinery products, and biofuels.

The graph above shows that oil supply (green) had outnumbered the demand (yellow) by about 1.5 million barrels per day. The excess stocks getting piled as shown in the blue bars.

The point

With slowing demand and excess of production, the prices kept sliding to almost $ 30 a barrel ! Pressure was on the OPEC to cut back on its production. The world’s largest producer of oil, Saudi Arabia, instead of cutting on its production increased it in order to hold its market share.This was the main reason why the prices kept descending.

The Prediction

Since the last few months, the production from the US did come down. But that’s mainly because the companies that is pumping out oil from sophisticated techniques are running into losses due to oil pricing crashes. But this cannot be considered as a relief because the lift on the US-nuclear sanctions on the Iran would again propel them to kick-start their production, further fueling the supply.

Many big weights believe that the prices could escalate below $30 while other believe that by the end of 2016, the prices could stable around $50-$60 a barrel. But this depends whether the Iran starts exporting oil faster. Also, America could taper its shale-oil drilling to curtail excessive supply pushing the prices up. And how could we forget the cold war between Saudi Arabia and Iran! A possible compromise is required from all sides otherwise the day is not far away when the oil market sinks in its own oil!

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