Crude oil prices dropped to $40 per barrel. This is the first time that this happened since 2009 in the wake of mounting consensus that cheap oil is a foregone conclusion. Oil traders, economic analysts, OPEC, and non-OPEC members came up with projections that prices will recover this year. This recovery seems unlikely next year or even in 2017.
The change in outlook can be attributed in part to the flexibility of oil producers in the United States. They keep on pumping crude oil at unparalleled levels regardless of cuts in expenditures mainly because of efficient drilling technologies. Unpredicted price rallies during the second quarter allowed some companies to lay claim to profitable prices for next year and add new drilling rigs. The decreasing prices of energy show that global economy growth has slowed down while lower import costs triggered concerns regarding dwindling inflation in certain regions.
Problems for Oil Exporters
Consequences of dropping crude oil prices are turning out to be more and more visible. As a result, oil exporters are facing critical economic issues as China (a major importer of oil) is slowing down while other oil importers have been experiencing various developments since the beginning of this year including unstable financial markets.
The slump in prices of oil since June 2014 was the third-biggest in six periods of decline during the last 30 years. This followed cycles of high oil prices and quick growth of non-OPEC oil sources. These were US shale oil, Canada’s oil sands, Mexico, Alaska, and the North Sea. The Organization of Petroleum Exporting Countries or OPEC reformed policy goals from targeting of prices to market share.
A look at past occurrences of sharply plunging crude prices indicates that these developments were normally followed by moderate recovery worldwide as advantages for oil importers did not happen right away. In certain cases, these were counterbalanced by current economic and monetary problems. For example, there was slow global progress after the oil price drop from 1985 to 1986. The average performance was associated with debt unrest in some major developing economies, sluggish growth in Japan and many countries in the euro zone. The stock market collapse took place in 1987.
Convergence of Recurring Factors
At present, there is a union of repeating factors such as lethargic recovery following the 2008 downturn; formative factors; and, risks caused mainly by standardized policies in progressive nations.
These are currently working in the world economy which could postpone or conceal benefits of reduced oil prices for the time being. There are also justifying factors right now which consist of regional overflows from economic stress in oil exporters; economic slowdown across countries that import crude oil; high debts, low-labor operation, and low growth of productivity in many advanced economies. These factors can persuade households and private corporations to accumulate savings instead of using up profits generated by reduced energy prices. Another perspective can be the early increase in savings will be quashed when consumers find out that energy prices remain low in the medium-term. It can also be that belief in economic potentials improves. This can initiate restricted demand which will in turn support global recovery.
Supply played a principal role in recent decline of oil prices. This augurs well for the ultimate impact on global economy. Yet, there is still an uncertainty that substantiates careful growth estimates but benefits for importers stand for positive aspects to present projections.
Saudi Arabia’s Position
The Kingdom of Saudi Arabia, which is the most dominant member of OPEC and the biggest oil exporter globally, can support world prices of crude by minimizing production. However, but it seems that the Saudi Arabian government will not resort to this. The OPEC leader needs prices to stay close to $85 in the long-term but it has ample reserve funds worth approximately $700 billion so it has the capacity to endure lower prices for the moment. Riyadh can eventually speed up market share in the long run in case a succession of lower prices compels high-cost producers to close down. Unfortunately, Saudi Arabia is not inclined to cut production any time soon. On the other side, some OPEC members continue to clamor for changes to help turn around the decrease of oil prices. These countries like Venezuela and Algeria are on the verge of bankruptcy.
Overall Assessment
The slump is not showing signs of slowing down. In fact, a recent report indicated that surge in inventory of oil reserves have caused prices of US oil to plummet to a new low. According to the International Energy Agency, US reserves were boosted by 2.6 million barrels contrary to claims of analysts that supplies will go down. The situation will not possible improve as demand continues to get smaller day by day.