You have probably seen it on the news and read about it in the newspapers, how the price of oil has been falling. There are many different stories that are being used to explain such a fall, however simply put this is the best modern day example of supply and demand in action.

Firstly, we need to remember that oil is sold in barrels. The price of oil is always based on US $, so this means that in the UK the strength of our currency against the Dollar does have some impact on price paid.

So what has been happening to the price of a barrel of oil?

oilpricegraph

As you can see the trend has been downwards for quite some time now. Just looking at the last quarter shows how the price of oil has dramatically fallen. As I write this you can buy a barrel of oil for $29 per barrel. If we go back to before the global recession that same barrel was costing around $120 per barrel!

So what has changed to cause such a dramatic decline in price?

 

Falling Demand

Demand for oil has dramatically decreased after the global recession / slow down. China who was one of the larger users and buyers of oil has seen growth half to around 7%, whilst also trying to make moves to become more service led. This will have an impact on how many barrels of oil that will be needed if manufacturing starts to decline as they look to the tertiary sector.

Add to this most western economies reporting slow growth rates. This means that less oil is being consumed in these markets. The USA who is also a large buyer of oil has also found a new substitute product to the oil that comes from the Middle East, fracking. Like it or loath it, fracking has brought about changes in the market.

Increased Supply

Fracking in the USA led to an increase in supply of oil on the market. It was always believed that so long as the oil price was more than $60 per barrel, then fracking was a viable option. Clearly OPEC and the Middle Eastern suppliers did not take well to this treat from a new entrant to the market and decided to increase supply / maintain supply levels, which ultimately brought down the price of oil per barrel. The hope of this strategy was to make it uneconomical to frack for this oil in the USA, however it appears that reports suggest that fracked oil is cheaper to produce than first estimated.

If fracking was bad for the existing supplier, then the move to lift restrictions on Iran and the Iranian exports of oil are a disaster. Iran claims that it has 500,000 barrels of oil to sell and will release these instantly on the market. If this happens then we can expect the oil price to fall even further. There are some predictions that it could drop as low as $11 per barrel.

You may be asking why Iran would want to do this? Maybe wondering why the existing countries wont just cut production and reduce supply? Well the belief is that this is a battle over market share. Iran used to be the largest exporter (seller) of oil before its trade restrictions, however Saudi Arabia then took this crown. It is believed the later does not want to lose this and will keep supply high in the hope of making it harder for others to achieve any market share gains.

Good Times

So as a customer who uses oil, the current times are looking good. The falling price when you fill up your car or the reduced costs for businesses to heat and transport goods, should in the end get passed on to the consumer. It should also enable inflation rates to be kept low for Western economies. However, there are some concerns that the economic growth you would expect from such low oil prices have yet to be seen in many economies. It will be interesting to see how this one plays out.