Of all the various commodities, oil is the one that people tend to be the most keenly aware of. That is because those of us who drive are constantly aware of the price of gas, of which oil is the principal determinant in its price. Even if some people may not be aware that the price of oil has fallen below $40 per barrel, consumers certainly recognize the decline in the price of gasoline.
Unlike services, commodities frequently have large price swings. For example the price of a haircut is not likely going to change too much on a year-to-year basis. Commodities, however, sometimes may see a doubling of a price, or a decline of 50% over the course of a year. This has certainly been the case with regards to the price of oil in recent decades.
People will obviously want to try to determine what causes these price swings. The answer may sound simplistic, but it comes down to supply and demand. Because most consumers will not change their driving habits significantly when prices change, a small change in supply can have a major impact on price. For example a 1% change in world oil demand or supply can impact prices by 10%.
When looking at the price of oil, it is important to differentiate between short and long-term effects. The most recent decline in the price of oil was due to OPEC failing to reach an agreement to curb oil production. Related to that was another recent development concerning the relaxation of sanctions on Iran, which will allow that country to export more oil.
There have been two major longer-term impacts that have more significantly impacted the price of oil. One is the significant increased production in the United States, which has had a major impact on world oil supply. The other is the slowdown in the industrialization of China, which previously had been a major source of increasing world oil demand.
The increase in supply from the United States is coming to an end. That is because the price of oil needed for projects to be profitable is considerably greater than where prices currently are. The cost of production is much greater here versus in the Middle East. Oil production has remained at record levels in the U.S. this year, as costs on many projects have already been realized.
However, new production is being curtailed sharply, and overall supply in the U.S. will start to decline in 2016.
The slowdown in demand in China will be a longer term occurrence. Most likely oil demand in China will stabilize near current levels, after a substantial increase over the past decade. However, oil demand will likely be increasing in other less developed countries, such as India.
One interesting point to consider is what the strategy of Saudi Arabia is going to be going forward. Saudi Arabia is the largest oil producer in OPEC, and has at times tried to alter its production to keep prices in a certain band. Because of the growth of oil production in the United States Saudi Arabia has lost some of its clout with regards to controlling oil prices.
Saudi Arabia in the past year embarked on a strategy to increase production in the hope of decreasing the oil output in the United States.
While that strategy could ultimately work, oil production in the United States has remained at higher levels than anticipated, and Saudi Arabia is now running a large budget deficit because of the decline in prices.
Some people may wonder about the significance of oil, as the world becomes more concerned with climate change. A point to consider is that irrespective of any agreements reached, unless there is a major discovery of a new technology, fossil fuels are still going to be a major source of energy production for at least several decades.
Solar, wind, and other renewables by themselves, will not meet the increasing demand of less developed countries use of energy.
The low gasoline prices we are seeing is increasing demand in the United States. This is occurring with strong auto sales, especially in the light truck area, as consumers are more willing to purchase less fuel-efficient vehicles when prices are lower. While gasoline prices have come down in Southern California, in a number of states, prices at the pump are less than $2 per gallon.
Our high taxes and regulatory requirements keep prices here much higher than the national average.
Looking forward it should be noted that very few long-term predictions concerning the price of oil or gasoline are very accurate. While major price movements will continue to occur in the future, that doesn’t mean that prices will ultimately stay at very high or low levels.
At current prices supply will be curtailed, and barring a major global recession demand will increase. This implies that prices will be higher again at some point, though the exact timing is hard to predict. However, would not expect prices to go up dramatically, as technology lowers the cost of future production both for oil and gas, but also for alternatives.
