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Oil: Nothing Goes Down (or Up) Forever

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Oil: Nothing Goes Down (or Up) Forever

Much attention has been given to crude oil prices over the past year or so, as commodity prices have plummeted—partly in reaction to the cheaper transport costs for other raw resources thanks to oil's plunge. Remarkably, crude oil has fallen more than 50% from its highs last summer, when it approached $120 per barrel. Today, both of the world's major crude oil benchmark prices are stuck below $50/bbl.

WTI Crude since 2011. Source: Bloomberg WTI Crude since 2011. Source: Bloomberg

As of Wednesday morning, even after posting gains early in the day, Brent crude sat at just $49.65/bbl while WTI crude was below $44/bbl, not far from multi-year lows. Many analysts have characterized the current situation in the crude oil market as finding its bottom, though it remains unclear how long this process will take, nor for how long prices will remain depressed.

Why are Oil Prices Falling?

The price for a barrel of crude oil, in its raw form, is generally governed by the supply of oil available on the markets and the demand for energy by all types of consumers—governments, corporations, and residences. No matter what other factors are cited as influencing prices, they only do so by affecting the supply and demand of the commodity. When people talk about the global economy slowing down, or industrial production losing momentum in China, they are also talking about demand for crude oil waning.

oil leak

The opposite is also true on the supply end. For example, technological advances in how oil is extracted from the ground, including the innovation of shale (fracking) operations, helps increase the supply of crude oil by allowing producers to pump more oil at the same cost.  Without any changes in the demand for energy, an increase in the supply means that prices will move lower. This even happens in the short run: as the United States, Iran, Saudi Arabia, and other countries have piled up massive stockpiles of crude reserves over the last year, more downward pressure has been placed on oil prices as buyers know that plenty of the gooey black fossil fuel is sitting in tankers, ready to hit the market at any time.

Remember when people were all talking about how we were imminently running out of oil?

A Time for Everything

Yet, this trend cannot simply continue in one direction forever. The present scenario where OPEC countries continue to pump oil at a rapid pace in order to squeeze out U.S. shale producers is admittedly abnormal, a short-term strategy in a war for market share. Yet, this plan can't go on indefinitely, especially as the more robust fracking companies are maintaining profitability through technological advances while the Saudis continue to bleed money by flooding the market with cheap oil.

Oil Well

The slump in oil prices is making it less expensive for developing countries to ramp up their energy consumption, however, which may in turn stimulate a future rise in demand for oil as those economies become more fully developed. Moreover, big developments in the global oil trade may lead to even more changes in supply and demand. While China is beginning to open its foreign oil imports to private refiners, political pressures in Canada are generating momentum for the idle Keystone XL pipeline deal.

Both developments hold uncertain outcomes, as neither China's rules on oil imports nor the political wrangling over Keystone XL in the U.S. and especially Canada are pointing toward clear-cut ends. Whether or not these events prove bullish or bearish for oil prices could swing current price trends rather quickly, just as the drop in oil prices last summer happened in a matter of weeks.

About the Author

Everett Millman

Steven Cochran

Precious Metals Market Analyst
BS University of South Florida (2002)

A published writer, Steven's coverage of precious metals goes beyond the daily news to explain how ancillary factors affect the market.

Steven specializes in market analysis with an emphasis on stocks, corporate bonds, and government debt. He writes a monthly review of the precious metals markets for SurvivalBlog.com.

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