Oil prices are plummeting — here’s why that’s a big deal.


The sharp drop in oil prices over the past month is one of the biggest energy stories in the world right now — with major implications for dozens of countries, from the United States to Russia to Iran. Ever since 2011, oil prices have stayed consistently high, hovering around $100 per barrel. But this year, they’ve dropped as much as 20 percent since June — and some analysts think they could keep falling in the months ahead: (NASDAQ) Why is this happening? Partly because the United States keeps producing more and more oil, but also partly because some conflict-ridden countries are starting to pump out oil again. Libya, for one, is massively boosting its oil output after major fighting had disrupted production. Iraq’s oil sector is recovering. All that crude is flooding the market, causing global prices to fall. A steep price drop could have lots of far-reaching effects. OPEC is currently squabbling over how best to respond. Russia, a major oil producer, could see its economy hit hard if prices keep falling. Some shale oil producers in North Dakota and Texas could find it unprofitable to keep drilling. And lower gas prices might curtail the recent drive for energy-efficient vehicles in the United States. Here’s a rundown: Why oil prices hit $100/barrel — and why they’re now falling Oil prices rose throughout the 2000s because global oil demand surged — especially in fast-growing China — and there simply wasn’t enough oil production to keep up. That led to the sharp oil spike in 2008 and subsequent recession. And once the recession ended, the same dynamics returned. Oil has hovered around $100 per barrel since 2011. Since 2011, the US oil boom has been offset by geopolitical disruptions elsewhere But because oil prices were so high, many energy companies also found it profitable to start extracting oil from difficult-to-drill places. In the United States, companies began using techniques like fracking and horizontal drilling to extract oil from shale formations in North Dakota and Texas. That led to a boom in production. Up until recently, that US oil boom has had a minimal effect on global prices. That’s because, at the same time, we were also seeing all sorts of geopolitical conflicts elsewhere in the world. There was a war in Libya that hurt oil production. Iraq was a mess. The United States and Europe slapped oil sanctions on Iran. Add it all up, and more than 3 million barrels per day of crude oil had been taken off the market by mid-2014 (global oil production is around 75 million barrels per day): (US Energy Information Administration) That helps explains why oil has hovered at around $100 per barrel since 2011, despite the US boom. "The best explanation for that is that it’s been a coincidence," said Michael Levi, an energy expert at the Council on Foreign Relations, in a recent interview. "We’ve had surprising US gains in production that have been offset by surprising losses elsewhere, due to geopolitical disruptions." But over the past month, those disruptions have started easing a bit. Libya’s oil industry has started pumping out oil again — with exports rising a stunning 810,000 barrels per day in September. And it’s becoming clear that the Islamic State in Iraq and Syria (ISIS) likely won’t threaten Iraq’s biggest oil fields in the southern part of the country. So now oil prices are falling, from their June peak of around $115 per barrel down to around $92 per barrel at the start of October. To be sure, oil is still much, much more expensive than it was a decade ago. And it’s entirely possible that the recent drop could prove to be only temporary (after all, we saw similar drops in 2012 and 2013, but new conflicts flared up in the Middle East and prices popped back up). But if the drop is real — and sustained — it could have a big impact around the world. OPEC is sharply divided over how best to respond One big question is how OPEC might respond to the recent fall in prices. OPEC countries — including Saudi Arabia, Iran, Iraq, and Venezuela — still produce 40 percent of the world’s oil. And OPEC members can, in theory, coordinate to cut back on supply in order to keep prices high. But it’s unclear whether OPEC will actually do this at its emergency meeting in November. For one, there are sharp divisions within the organization. Some OPEC countries need very high prices to "break even" on their budgets and pay for all the social spending they’ve racked up in recent years. Iran, for instance, likely needs prices at around $130 per barrel. But Saudi Arabia can probably live with prices closer to $90 per barrel. OPEC "break-even" prices in 2012. (Matthew Hulbert/European Energy Review) Iran is at odds with Saudi Arabia over whether to cut output Andrew Critchlow of The Telegraph reports that this is already causing tensions within OPEC: "Iran’s Oil Minister Bijan Zanganeh [is] calling for Opec to urgently cut output to stem the sharp recent decline in prices, which threatens the Islamic Republic’s fragile economy after years of restrictive sanctions. … However, the Gulf’s Arab states are all sitting on huge cash piles that are held overseas through sovereign wealth funds and foreign currency assets that can be drawn upon to help them weather any short-term drop in oil export revenues." How OPEC responds could go a long way to determining oil prices. If the group cuts production, oil prices could in theory rise again. If they let things slide, oil prices might keep falling. How lower oil prices affect other nations — from Russia to the US Lower oil prices could have lots of knock-on effects around the world. Take Russia, which needs oil to hover around $105 per barrel to break even on its budget and depends on oil sales for foreign currency earnings. A sustained fall in prices could cripple the Russian economy. (Indeed, some energy analysts are already wondering if an oil crash could force Russia to pull back in Ukraine and elsewhere.) A sustained fall in prices could cripple the Russian economy In the United States, a fall in prices would have more subtle impacts. Overall, it would likely boost economic activity — as gasoline prices fell and US households spent less on fuel, giving them more money to spend on other things. But it wouldn’t benefit everyone. Oil producers in the shale regions of Texas and North Dakota typically don’t find it profitable to drill unless prices are relatively high. A report from analysts at Baird Energy this week suggested US oil production could see a "sustained pullback" if global prices stay below $80 per barrel. A drop in prices could also affect the vehicle sector. Over the past few years, average fuel economy for new cars and trucks in the United States has been rising sharply in response to higher gasoline prices. But in August, average fuel economy actually fell slightly. Lower gas prices meant that more people were buying trucks and SUVs: (Michael Sivak and Brandon Schoettle, University of Michigan Transportation Research Institute) Now, overall fuel economy will still keep rising over time — because the federal government has imposed new fuel-economy standards on cars and light trucks that will keep rising through 2025. But lower gas prices might convince more people to buy SUVs and trucks instead of smaller cars. One final, major caveat to keep in mind: It’s hardly guaranteed that world oil prices will keep falling. Some analysts are now suggesting we’ve entered a new era of oil "abundance." But the world is highly unpredictable. Perhaps new conflicts will arise in oil-producing regions. Or perhaps the US oil boom will weaken. Or perhaps something else will happen. Predicting the future is always difficult — but it’s especially difficult when it comes to oil.


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