Thursday, February 19, 2015

Why Crude Oil Prices are Falling ?

Crude Oil prices are falling at a very fast pace. The prices have eroded by 50% in past one year which is causing a lot of disruption in global economy. Some of the countries like India who are dependent on imported crude are benefitting out of it and producers like Iran and Russia are bleeding due to reduced prices.

There may be multiple reasons for the fall in crude oil prices. Some of the reasons which I feel may affect the pricing are below stated but the real reason may be very different.

Theory X

Reduced Oil Demand in Future:  The current price is the reflection of the future demand which has reduced due to poor health of global economy. The reduction in demand is may be result of cooling of Chinese economy, uncertain Europe and other countries. At the time when anticipated demand was reducing US opened flood gates of the Shale Oil. The prices started falling as soon as the US Shale Oil production started to increase and it started competing with crude oil from the crude oil supply from OPEC.

The theory fails to explain why the prices will fall as much as 50% as conditions are still better than what the world has already seen. Infact when US is growing at 3.5%, the size of US growth can provide fillip to the international demand and can absorb some of the supply. Why OPEC didn't reduce its production when the demand was seen to be lower like it usually do to support the price in the market ?

Theory Y

USA counter strategy for Iran and Russia: Both Iran and Russia who do not share very good relations with USA are largely dependent on the sale of crude oil to sustain its economy. The price reduction will hurt them the worst. It also suggests that wars between the country will increasingly be more economic than traditional. The theory has its merit and demerits, the shale oil production is largely held private in US and works based on economies. So it may not be the government who is driving the production.  OPEC could also have reduced the production but it never went for it.

Likely Reason

Technology: For years together the world has been dependent on crude oil and coal for its energy need. There may be some new technology which is about to enter the market which both USA and OPEC is aware. The technology can be Solar or other rewnable energy which can even change the pecking order of the economic strength of the countries. Once such a technology comes, the oil fields will be worthless and it makes sense both for USA and OPEC to pump out as much oil as possible without worrying about prices till such a thing happens.


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