Like any other commodity, oil is volatile, so it is no surprise that we are in this situation again. To break down the economics of it all into a simple explanation – the world demand for oil is currently much lower than the world supply of oil, therefore the price has fallen. While consumers are happy and benefiting from the lower price… Unfortunately the oil industry is suffering severely.
So how did we get here?
There are many factors that contributed to this big difference between oil’s supply and demand. One major factor is that new drilling technology resulted in a major increase in U.S. oil production which in turn caused global supplies of oil to increase. And all the while, consumers have been developing conservation habits to save money on energy.
We have seen this happen in many different industries, when innovation and new information dramatically decrease the profitability of an existing industry. In some cases, the industry becomes redundant and is completely wiped out. Will this happen to the oil industry? Highly unlikely, but it looks as though it will be many more years before the price will return to the heights of $100 a barrel. Just to put our current situation in perspective: For the oil price to move above $60 a barrel, the whole world will need to reduce their current production levels by 4%. And this is looking even more unlikely with the sanctions lifted on Iran, and the expectation for them to add another million barrels a day over the next 2 years.
Well how do we fix this?
The solution to this problem involves multiple players. Essentially what needs to happen is the countries that are producing oil need to produce less, at least until the supply falls below the demand again, but this is easier said than done. Exporters of oil in the Middle East and other regions have refused to reduce their own output. And as previously mentioned Iran only has plans to increase production. There is however a possible silver lining. In the same way that the rise to $100 a barrel attracted new investments and increased production, the fall to $30 a barrel may discouraged new investment and cause decreased production due to lack of profitability. If this happens the supply of oil will naturally fall to equal or less than the demand and the price will increase again.
So as for the question of what’s next, a number of different factors will play into the picture. I guess we’ll just have to wait and see how the economics of it all plays out.