Why oil price is falling?


First of all, oil price did not fall suddenly. It is falling since last few months. Only recently it has become big news because compared against last few months, it has now fallen too much.

So how much it fell?

Compared to last year this time, crude oil price fell by ~50%. Current oil price is ~ $50 per barrel.

So what caused this fall in price?

Any price fall can be explained using simple economic theory of supply and demand.

However, the tricky question is what caused imbalance to supply demand theory.

In past few months, supply has gone up but demand has fallen.

Why demand has fallen?

  • Development of more fuel efficient machines, cars etc.
  • More usage of alternate energy sources like wind power, electricity (well it requires fuel to some extent but nevertheless)
  • Reduced economic activities in many countries around the world

Why supply has gone up?

  • USA is producing more oil especially via shale gas. This has caused reduced demand (from other countries exporting oil) from USA.
  • Fracking i.e. release of natural gas below surface has led to less demand on traditional oil.
  • Libya and Iraq continuing to produce oil in spite of experts expecting fall in production from there.
  • OPEC, which often controls oil price indirectly, has refrained from restricting production and let it follow a natural path. Now this is somewhat mystery why OPEC is not intervening. Some analysts say that Saudi Arabia (http://en.wikipedia.org/wiki/List_of_countries_by_oil_production ) has decided to carry on normal production as it thinks restricting supply, although may bump price up, will help Iran and Russia whom Saudis don’t have good relationship.

What is the effect of oil price fall?

It is difficult to predict, but in general it is believed that fall in price is good for overall world economy as it will lead to cheaper goods and thus can lead to more economic activities by consumers.

Russia has been affected negatively because it is generating less income via export but still need foreign currency for import. Some companies associated with oil industry have been affected by fall in profit obviously.

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