Oil prices – why so low?

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Oil prices have recently hit their lowest point since 2003. Let’s explore what factors contribute to this good (or bad?) feat!

Let us begin with simple economics: supply, demand, and equilibrium. Supply is defined as the amount of a certain product firms will produce at a given price. Likewise, demand is defined as the amount of a certain product consumers will buy at a given price. Equilibrium is a point at which the quantity demanded is equal to the demand supplied.

If the demand of a product increases, the equilibrium price increases, since people are more willing to pay more for that product (below). To keep up with this, suppliers are willing produce more thus the equilibrium quantity increases as well. Conversely, if the supply of a product increases, the equilibrium quantity increases, since more firms can produce at a given price. Since consumers do not want a higher quantity at the same price, the equilibrium price decreases to match demand with supply.

shifting-supply-demand-curves

 

So why does this matter? For oil prices to decrease, we see that either supply increased or demand decreases. We’ll explore both options further.

How is oil being supplied? One main source of oil is OPEC, the Organization of the Petroleum Exporting Countries, which is a group of 13 petroleum-exporting nations who work together to increase profits. These countries constitute 40% of global oil production, which gives them a lot of power in influencing oil prices. What these countries have realized is that if they all agree to reduce their production, they decrease supply and therefore increase equilibrium price. This increase in price gives each country more revenue and thus profits when it comes to oil production! Looking into OPEC production, we see that OPEC has in fact increased production, but not enough to account for the total decrease in oil prices.

One huge increase in oil production comes from (albeit a little surprising) the United States! Over the recent years there have been huge advancements in the extraction of shale oil, which is oil produced from oil shale rock fragments. This makes the oil production market more competitive, and OPEC and other major produces must now compete with more sources of oil and different markets.

Now that we’ve covered supply, what is happening to demand? Demand has decreased in many countries, the notable ones being China, Brazil, and countries in Europe. The biggest factor behind this decrease in demand is poor economic performance. A bad economy = people have less money = demand of products (like oil) is decreased.

We now have a good idea as to why oil prices are decreasing – but how long is this going to last? Will OPEC decrease production enough to raise prices back up? Can the US continue to produce oil at high quantities? Share your opinions in the comments or invest in the oil market if you’re really confident in your beliefs 🙂

— Akshay

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