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Oil Supply Is Up, Forcing Oil Prices To Drop

Economic Implications Of Oil's Drop (Part 3 of 7)

(Continued from Part 2)

Increase in oil supply putting pressure on oil prices

On the oil supply side, the long-run U.S. shale oil renaissance has helped propel U.S. crude oil production from a low of about 5 million barrels per day in the mid-2000s to a 30-year high of about 8.7 million barrels per day. This structural trend intersected a series of positive supply developments over the last three months, including airstrikes against ISIS, the re-opening of Libyan ports, the fading of risks surrounding Russian oil supply and increasing Iranian shipments. Finally, Saudi Arabia signaled that it would no longer act as the marginal producer of oil, and instead committed to maintaining market share.

Market Realist – The forces of demand and supply for oil can be held largely responsible for the fall in prices. While demand growth has cooled off due to economic weakness in countries such as China (FXI) and Japan (EWJ) and the Eurozone (EZU), oil supply has been on the ascendant. This has thrown the balance out of whack, causing excess oil supply (XOP) and a steep fall in oil prices (BNO).

The following are the main points to look at when assessing the extent to which excess oil supply is causing prices to drop:

  • The US Shale Boom – The fracking revolution elicited a boom for shale-oil-rich regions. The shale boom transformation increased the production of US crude oil manifold and propelled it to multi-year highs. According to US Energy Information Administration, or EIA, estimates, US crude oil (BNO) output for the week ended December 5, 2014, increased to 9.1 million barrels a day, its highest level since 1983. The graph above shows how US production has increased remarkably over the past ten years.

  • OPEC refusing to cut output target – OPEC voted to keep its target output at 30 million dollars a day on November 27, 2014. The refusal to cut production signals attempts by the OPEC (Organization of the Petroleum Exporting Countries) to retain its market share. The energy minister for the United Arab Emirates also stated that OPEC is likely to keep its output unchanged for the next three months and would not cut production even if oil prices were to fall to $40.

  • Increase in production in other countries – Oil supply is high due to an increase in production in many other non-OPEC countries. According to EIA estimates, Canada augmented its crude oil production from 2.5 million barrels per day, or bpd, in 2009 to 3.3 million bpd in 2013. Russia (RSX) too saw an upswing in production levels, from 9.5 million bpd in 2009 to 10 million bpd in 2013. The non-OPEC production growth has been outpacing the growth in world consumption for oil, as you can see in the graph above.

The increase in oil supply, when contrasted with the decline in demand, helps explain the drop in oil prices.

Continue to Part 4

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