Reasons and Effects of Oil Price Free Fall

Posted On Wednesday, Feb 25, 2015

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Recently the prices of oil were grabbing all the headlines, the price of oil (usually quoted as US Dollars per barrel) fell faster than a meteor hurtling towards our planet. Back in June 2014, the price of Brent crude was up around $115 per barrel; in January 2015, it had fallen by more than half, down to $49 per barrel. Oil was again in the news recently as its price, once again fell below $50 per barrel on the 23rd of February, 2015.

The OPEC (Organization of Petroleum Exporting Countries) met when the prices were at a free fall and decided to... do nothing! There are several reasons behind the fall in oil prices. Will briefly touch upon each and then connect the dots to you and how the international oil prices affect your wallet. Yes, they actually do.

Reasons for the Free Fall
To understand why the prices of oil fell, we need to recognize why the prices of oil were high in the first place. To unravel this, let’s turn the page and go back to college and Economics and the rule of demand and supply, which you need to keep at the back of your mind as you read this article. The rule is – if demand far exceeds supply, the prices will rise, if supply rises and the demand is more or less constant or reduces, then prices will fall.

Now to some of the reasons for the fall in oil prices:
Emergence of Shale fuel in the US
The costs of importing crude oil hit many economies, just to give you an example, India’s oil bill for the year 2013-14 was $143.8 billion which is about Rs 8.94 lakh crores! The oil bill of the United States is much higher, pegged at around $246 billion for the year 2014. That’s almost around the GDP of Greece in the year 2013.

Given the fact that the oil import bill tends to be so high, America started actively exploring oil in shale formations in North Dakota and Texas region. While this fuel which is a substitute for the conventional crude oil is costly to extract, it would be cheaper than importing fuel from the Middle East. As a result, since starting explorations in 2008 the US has added another 5 million barrels of shale oil to the global crude production of about 75 million barrels a day.

Economic interpretation: Supply went up, demand was relatively static and the price of oil started to fall.

Exports of Oil from Iraq restarted
According to reports, Iraq exported record amounts of oil in Jan 2014 and kept the trend flowing. Oil exports were the best way for the machinery of this beleaguered economy to start moving. International sanctions were eased and the embargo on the import of fuel from Iraq was also lifted. This led to a hitherto restricted supply to hit the oil markets again.

Economic interpretation: Supply went up, demand was relatively static and the price of oil started to fall.

OPEC Stance
Given that the prices of crude oil were on a downward spiral, many expected that the OPEC countries, in their November 2014 meet, would decide to cut production; instead of doing so, Saudi Arabia, the largest member of the OPEC and the other countries decided to continue producing more oil.

Therefore the cost of oil per barrel could fall to such levels that it becomes uneconomical for America and Canada to continue tapping their shale formations for oil and increase dependencies back on the OPEC countries.

Economic interpretation: Supply went up, demand was relatively static and the price of oil started to fall.

Slowdown in the Chinese and EU economies
The key reason why oil prices rose sharply in the last decade is the surge in global demand, especially from China. China is the largest net importer of oil. However with its economy in a slump its consumption of oil has gone down considerably.

The European Union economies too, which are huge consumers of oil, are in a stagnant growth phase. Collectively the slowdown in these economies has led to considerable drop in the global demand of crude oil.

Economic interpretation: Demand decreased while the supply kept going up so the price of oil started to fall.

When all these factors came together the price of oil dropped to an all time low of $30 per barrel. And is now at around $49 per barrel at the time of writing this article.

How do oil prices affect you?
For those of us whose cars are their second homes and like to drive daily and even take the car when we go out on holidays; the falling prices of crude oil are proportional to a drop in fuel prices. Petrol and Diesel prices have fallen since the increased volatility in international oil prices.

In India commodities and other items are transported by road, the fall in diesel prices leads to lower costs of transportation, therefore lowering the cost per unit, and therefore lowering prices of essential commodities making it that much more affordable for the common man.

Falling oil prices are good news for us since it increases the savings pool by that much, allowing us to invest that bit more towards that financial goal.



Source: Petroleum Ministry India, US Gov Census, World Bank, Bloomberg


Disclaimer, Statutory Details & Risk Factors:


The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

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