Oil price volatility, what caused the price of oil to go from $10 to $145 per barrel?

At the end of the 1990s two broad market events occurred that collapsed the equilibrium price of oil in the stock market. The demand for oil was decreased, and the supply of oil was increased. The decrease in demand and increase of supply is described perfectly in our Economics textbook “Supply Increase; Demand Decrease What effect will a supply increase and a demand decrease for some good (for example, apples) have on equilibrium price? Both changes decrease price, so the net result is a price drop greater than that resulting from either change alone (57). The first was Iraq’s return to normality and stability, which allowed for Iraq to drastically increase its oil production. And the second Macroeconomic event is that the Asian countries with leading GDPs were engrossed in a financial crisis causing Asia’s demand for oil to decrease significantly.

Notice the chart between 1991 and 1997 is the gulf war and how low the oil production is, and notices the spike in Iraq’s oil production after the war. The market would have had its equilibrium at around $34 a barrel just before Iraq nearly doubled its daily output of oil barrels per day from 750,000 to 1.5 million barrels a day, from which Iraq’s supply to the market only increased.

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Here we have a chart created by the World Bank, which records the falling GDPs of the Asian countries that comprised the Asian financial crisis. The fall in GDP and fall in the rate of exchange of the crashing Asian countries would necessarily reduce the consumption/demand of oil this mass of Asian countries demanded pre Asian financial crisis.

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As the Asian countries passed through the crisis demand returned to normality, and these countries continued to grow at developing country rates increasing the demand for oil from these countries. From the Asian financial crisis to now, China has also increased its demand for oil so much that it has over taken the U.S. as the number 1 consumer of oil in the world. This massive addition to the demand of oil has helped to continuously increase the equilibrium price of oil. The 2007 global financial crisis and 2008 global recession which the world is still recovering from also devalued the worth of financial markets worldwide, and reduced the worth of global currencies such as the U.S. which caused the price oil, which is a commodity to finally spike to its $145 dollar level, because the low worth of the paper currencies became devalued by 50% compared to commodities like oil and gold for example. In essence, the rise of the price of oil to $145 a barrel was caused by inflation.

crude-oil-price-history-chart-2015-07-18-macrotrends

 

 

(2) Why did a barrel of oil go down from $145 to approximately $60 in recent months?

 

In 2014 oil prices dropped 50%, from above $100 a barrel to as low as $50 a barrel. The reason why is because one of the largest suppliers of oil increased its supply to the market by a minimum of 680,000 barrels of oil per day. According to a Nov. 2014 article in Bloomberg Business, the “Saudi minister al-Naimi reiterated on April 7 that OPEC will only pare output to rebalance the global market if other producers share the burden. Al-Naimi has said several times since OPEC’s Nov. 27 decision that the group’s supplies shouldn’t be curtailed to make room for higher-cost producers. (Carpenter, Saudi…Rising Market Share Fight). It has been speculated that the higher costs producers that are being referred to are the Shale Oilers of America who are reaping profits from the high price of oil that is maintained by OPEC’s restraint of its oil production.

Saudi Arabia’s strategy is to take a temporary reduction in their profit per barrel by driving the price of oil down over 50%, Saudi Arabia accomplishing this by supplying more oil than the market demands; and the reason why the Saudi Arabia sees the loss as temporary is because, while Saudi Arabia has the lowest costs of any oil producer in the world, other oil producers who had thin profit margins while the price of oil was $100 a barrel and above, will cease participating in the oil business because they will be profitless and bankrupt; the perfect example of the low profit margin producers would be American shale oil producers. For Saudi Arabia’s strategy to be ultimately successful the low price of oil would need to result in pushing out the shale oil producers of the U.S., and after driving out the other producers, then the amount of oil supplied to the market will reduce back to its original output before Saudi Arabia increased its oil production because the Shale Oil producers will be diminished, and thus the oil prices will rise, though perhaps not back to $100 a barrel, but high enough for Saudi Arabia to recover profits by selling many more barrels per share even at a lower price.

 

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(3) What is the equilibrium price of a barrel of oil today?

 

The price of per barrel a day closed at $59.13, and has been hovering around the $60 range for a while now. This is the new equilibrium price, as $60 per barrel of oil is the price that the largest supplier in the market (and leader of OPEC) is satisfied receiving per barrel of oil to supplied.

 

In an article from financial analyst house “Reuters” by analyst Alex Lawler, the current equilibrium price of oil is talked about, but more importantly the article quotes the OPEC leaders at their OPEC meeting in Vienne on 6/5/2015. In short, Saudi Arabia’s increase of supply has established the current equilibrium for oil at $60 a barrel but the other OPEC members who had been voicing that seeking $100 a barrel for oil “would be fair.” At the recent meeting in Vienne the Opec members other than Saudi Arabia are now saying that $75 a barrel would be a fair price, in hopes that Saudi Arabia will curtail its increased production in order to support an equilibrium price of $75 or above. The Reuter’s article states in light of the current equilibrium price and the comments of OPEC members other than Saudi Arabia, “The comment adds to signs that many of the world’s biggest producers are gravitating towards a new equilibrium price that they believe may be low enough to deter competition from higher-cost frontiers without wrecking OPEC members’ budgets (Reuters, OPEC Seeing $75).” This quote from Reuters is consistent with my current analysis.

 

 

Works Cited

 

Carpenter, Claudia. Saudi Oil Output Rising Amid Fight For Market Share. Bloomberg

Business. Feb 2015. Web. http://www.bloomberg.com/news/articles/2015-02-19/saudi-arabia-oil-production-rises-to-about-10-mln-b-d-pira

Lawler, Alex. OPEC price hawk Iran joins others seeing $75 oil as “fair”. Reuters. June 2015. Web.

http://www.reuters.com/article/2015/06/05/us-opec-meeting-iran-price-idUSKBN0OL0UC20150605

Rahemtulla, Karim. The Fall of U.S. Fracking?. Wall Street Daily. Nov. 2014. Web.

http://www.wallstreetdaily.com/2014/11/11/u-s-fracking-industry/

Smith, Grant. Saudi Arabia Adds Half A Bakken. Bloomberg Business. Apr. 2015. Web.

http://www.bloomberg.com/news/articles/2015-04-16/saudi-arabia-adds-half-a-bakken-to-global-oil-market-in-a-month