Reasons for Crude Oil Price Drop - Report Example

REASONS PRICE DROP OF CRUDE OIL By of the of the School Crude oil is a determinant of economic progress. This means that the fluctuating price per barrel is of important not only to oil dealers but also to nations. In the recent past, the prices of crude oil have experienced a quick decrease in the world’s oil market (The Economist, 2014). Such changes have made many countries that entirely depend on oil exportation experience quite a hard economic time as a result. In my opinion, a combination of factors has played a significant role in the dropping prices of crude oil. Some of the factors include the oversupplying of crude oil, inflated American currency and the impact of Organization of the Petroleum Exporting Countries (OPEC). Another factor is the several deals that America has made with war-torn oil-producing countries (Krauss, 2015). In this essay I will further discuss the impact of the factors mentioned above. Total petroleum output in the year 2015 is expected to go up to 9.35 million barrels every day. The quantity is slightly more than the 9.3 million barrels daily forecast in the previous period, the Energy Information Administration (EIA) highlighted last week in its monthly short-term energy outlook. Independently, oil stocks went up more than expected marking a higher overall than at any other time for the last 80 years and more. The American commercial crude oil stocks rose by approximately 4.5 million barrels from the previous week; the EIA said. The Organization of the Petroleum Exporting Countries (OPEC) was founded in Baghdad, Iraq, with the signing of an agreement in September 1960 by five countries namely Islamic Republic of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. A main reason in evaluating oil price is the OPEC policies on the export of crude oil to the global market. As a result, the American oil output could be negatively affected in the recent years due to low oil prices offered by the OPEC countries (Krauss, 2015). In addition, OPEC also outlines that the lower global oil prices may have slightly affected the barrel output from other sources, such as shale. Shale can be used in substitute to crude oil, yet it is way more costly to extract. The OPEC is a significant body in the oil industry (The Economist, 2014). Therefore, its decisions and marketing affects trade in crude oil because it controls a large percentage of the world’s fuel production. This means, any decision that they make directly affects the market prices of this important raw material. In this case, the petroleum trading set may pick out actions targeting their competitors in order to gain control of a larger market (Pedersen, 2014). Such activities may include flooding the market with the commodity or raw material leading to market forces coming into play and hence prices decline. The decrease in the prices would in turn translate into losses and limit the number of traders in the commodity. This means that OPEC enjoys a monopolistic advantage in the market. A monopolistic advantage in simple terms means when a firm in a specific market enjoys advantages because of its large size in comparison to its competitors. Other than price control other monopolistic advantages include economies of scale, superior knowledge in finance and management. The unplanned supplies of the product resulting from crucial OPEC decisions facilitate price disruptions and tighten conditions of the global market (Krauss, 2015). According to analysts, a key factor for the sharp drops in the prices of oil is the continuing unwillingness of the cartel of oil producers, OPEC, to intervene and stabilize the highly oversupplied markets. So far, the prices of the benchmark crude oil of OPEC have reduced by approximately 40 percent since it refused to cut production at a meeting in Vienna. The organization has been faced with conflict of interest or so to speak divided opinions on which direction to take. Countries like Algeria, Iran and Venezuela have been pressurizing the organization to cut production in a bid to firm the prices up. On the contrary, countries like the United Arab Emirates, UAE), Saudi Arabia as well as other gulf allies has been declining such demands. At the same time, Iraq has actually been increasing the production thus pumping more oil into the market thus worsening the fall in prices of oil (Pedersen, 2014). According to Saudi officials, they are declining to cut production because such a move will make them to lose market share and in result only benefiting their competitors, the countries they detest, for instance, Russian and Iran.. Their strict stand will only lead to further fall in the prices of oil. They are unwilling to sacrifice their market share so as to restore the oil prices since they can tolerate the low prices quite easily due to their $900 billion in reserves. Another possible reason for the sharp decline in oil prices is the existence of conspiracy (Krauss, 2015). There are many conspiracy theories floating around in a bid to hurt other economies. Even though there is no evidence supporting such conspiracy theories, some oil executives have noted the Saudi Arabia and United States may want to hurt both Iran and Russia. This is a sufficient motivation for the two countries to force down the prices of oil. For instance, in 1980s dropping oil prices aided in bringing down Soviet Union, and that is what is likely to happen (The Economist, 2014). The prices of oil are usually determined partly by actual demand and supply and partly by expectation. In addition, demand for energy is usually closely linked to the economic activity. This implies that demand spikes during winter especially in countries that do use air condition. In addition, it spikes during winter in the Northern Hemisphere. Therefore, another reason for the plummeting prices of oil is the weak economic activity, high efficiency as well as increasing switch to other fuels other than oil (Pedersen, 2014). Another factor is that over the years, the United States of America has become the largest oil producer in the world. It currently imports less of crude oil thus creating a lot of spare supply which has led to the sharp decline in the prices of oil. For example, the boom in shale oil production has cut by almost half the imports from OPEC as the US has stopped importing crude from countries like Nigeria. On the other hand, the prices of oil have declined due to negative European economic outlook. The continent has been experiencing slow growth due to recession. For example, the Germany’s exports have declined by 5.8 percent. Slow or reduction in economic growth lowers demand for oil thus resulting in too much supply. Wold economies are currently struggling due to recession and slow economic growth leads to low demand for oil. Firms ship less; individuals travel less, as well as consumers holding back their driving desire and habits to save money (The Economist, 2014). Another factor that could have sent oil prices plummeting is technical correction by oil traders. The oil traders on anticipating that the World Bank would intervene in stimulating economic growth drove the oil prices up. However, when they noticed that the intervention was failing, they had to rethink their outlook. In so doing, the hope of the stimulus bubble burst thus causing the prices to fall sharply (Krauss, 2015). Iran is considered to be one of the most powerful countries in the world due to mainly its very advanced nuclear program. The American foreign policies also affect the pricing of crude oil. Obviously, deals to counter terrorism directly affect the quantity of the commodity in the market. America has been one of the main players in the war on terrorism, or in my opinion main players in serving the United States political goals on the region. As such, the country has formulated various policies aimed at reducing terrorism. Such policies have been affected towards Iran for their alleged involvement in nuclear weapon manufacturing (Pedersen, 2014). In this case, the country is prohibited from placing their products in major global markets. However, USA and Iran have signed several deals that have seen the reintroduction of petroleum product. In this case, the total global supplies increase leading to the market forces to push the prices downward, in simple terms as supply increases it will force demand to decrease. The increased amount of the product for a constant market target market results in a decline in the prices of the products. The inflation of the American dollar affects values of particular country currencies. The dollar has significantly increased in value more than other foreign currencies. This means that other currencies appear to be struggling in the presence of the dollar (Pedersen, 2014). As mentioned above, the artificially made demand has pushed the prices of the commodity to the floor. In addition, it is important to point out that experts are warning that if this negative trend continues many small dealers will be out of the business since many practice hoarding. This is simply because the small companies or dealers cannot actually apply such strategies of buying more stock when the prices are favourable because they have a smaller budget in comparison to larger companies. Since global commodity prices are usually quoted in dollars, an increase in the strength or value of US dollars is likely to make oil prices to fall. For instance, the surge that was experienced in the US currency during the second half of 2014 lead to a sharp fall in the main commodity indexes. Since a dollar has been a key driver in almost everything, an increase in its value puts the market under tremendous pressure thus making the value of commodities to fall (Krauss, 2015). Another factor that could possible lead to the declining oil prices is the Iran nuclear deal because it is able to add to the oversupply. The advance in negotiations toward a likely nuclear deal with Tehran is able to lower the prices of oil because it could lead to more Iranian oil exports. Iranian nuclear deal is aimed at removing Western sanctions against Tehran. The removal of the sanctions is likely to further affect the global oil market which is already experiencing oversupply (The Economist, 2014). The crises in the oil-producing nations have significantly affected the pricing of the precious commodity. Countries such as Iraq, Saudi Arabia, Libya, and Iran have continually had the trouble with civil wars thereby affecting the production and export of the product to the international market. Such impact has led the demand to decline in the weak economies. Other nations that entirely depended on the crude oil for production are also finding alternative sources of energy. The trend, therefore, has resulted in the surplus of the product in the market that in turn causes the reduction in the prices (The Economist, 2014). Climate change presents serious environmental challenges. We live in a world that is developing day by day at a very fast pace, every day we are marking new changes at all sectors. In order to deal with the problem, nations shift to other sources of green energy that produce little or no emissions to the air. Energy sources such as wind power, solar power have gained vital importance especially in the developed nations. The shift towards these sources of energy negatively affects the use of crude oil thereby affecting the import and export of crude oil. Governments also offer subsidies for firms that promote other forms of energy perceived as friendly. Thus, they attract more entrepreneurs to go green and in turn affect the supply of the commodity causing price drop. In addition, other nations have discovered oil deposits in their countries making them become energy sufficient. Instead of importing the crude oil, the countries prefer to use their own thus locking out potential exporters of the product. In the same line, the United States has emerged as one of the main producers of oil in the world (Krauss, 2015). Lastly, another possible factor for the declining oil prices is the presence of a large number of smugglers, such as illegal dealers and miners. Smuggling and other illegal business activities are known to cause much damage and harm to businesses, especially to the international trade. In this case, these acts tend to increase the total amount of supply in the market. As a result, the market forces the prices downward (Pedersen, 2014). The sharp fall in global oil prices has led to significant shortfalls in revenues in a good number of energy exporting nations. however, many consumers is a good number of oil importing nations have been paying less in heating and lighting their homes as well as driving their cars. This has led to mixed blessings to the countries. Russia, for instance, has been hit very hard with the falling prices of oil. It loses approximately $2 billion in revenues per dollar fall in the prices of oil and this is likely to shrink Russia’s economy if the prices fail to recover. On the other hand, the fall in prices is likely to benefit Europe. A fall in oil prices by 10 percent is likely to increase the economic output by 0.1 percent (The Economist, 2014). In conclusion, it is notable that the petroleum industry is quite significant, and it is the primary source of energy for engines and other machines. As such, the industry cannot be ignored when faced with circumstances that adversely affect its effectiveness. Some of the factors analysed above include the effect of OPEC, the Iran nuclear deal that will add to the oversupply the American dollars inflation, the existence of conspiracy theory, negative European economic outlook, smuggling, the weak economic activity, high efficiency as well as increasing switch to other fuels other than oil. In addition, there is the continuing unwillingness of OPEC to intervene and stabilize the highly oversupplied markets. These factors lead to destruction and uncertainty in the industry; however, various efforts are underway to restore a normal price. References Krauss, C. 2015, Oil prices: What’s behind the drop? Simple economics, The New York Times. 17 May 2015. Retrieved from: http://www.nytimes.com/interactive/2015/business/energy-environment/oil-prices.html?_r=0 Pedersen, C. 2014, 5 Reasons Oil Prices Are Dropping, oil price, accessed 17 May 2015. Retrieved from: http://oilprice.com/Energy/Oil-Prices/5-Reasons-Oil-Prices-Are-Dropping.html The Economist, 2014, Why the oil price is falling, accessed 17 May 2015. Retrieved from: http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4 Read More