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A State of Freefall: Examining the Factors behind the Falling Crude Oil Prices

A State of Freefall: Examining the Factors behind the Falling Crude Oil Prices

By Pradyut V. Hande

Edited by Shambhavi Singh, Senior Editor, The Indian Economist

In 2014, the Global crude oil prices have continued to remain in a state of freefall month after month. Presently, pegged at USD 85/barrel, prices have fallen by 4.4% in October, 2014 alone. In fact, this trend first began in July, 2014 and prices have declined by almost 20% since. This appears to be a cyclical downturn spearheaded by both demand and supply side factors. The prices hovered over USD 100/barrel since 2011 on the back of escalating demand from emerging economies such as China and India, the current sharp and continuing fall in crude oil prices is meritorious of closer examination.

Supply Side Dynamics

In the current scenario, the USA continues to ramp up shale oil production in the states of Texas and North Dakota at an exponentially increasing rate. Slated to enhance total crude oil production to a three decade high, the country’s crude oil stockpiles have increased by almost 2 million barrels by the first week of October, 2014. In fact, according to a report released by the USA-based Energy Information Administration on October 7; oil production in the USA has increased to 8.4 million barrels a day as compared to 7.4 million barrels a day, this time last year. That translates into greater supply in the international market. Furthermore, crude oil production by the OPEC member states has also increased to a two year high. For starters, Libya which was combating the undesirable socio-economic ramifications of Civil War has drastically increased production to over 800,000 barrels a day in a concerted effort to kick start its flagging economy. Geopolitical turmoil in the regions of Iraq and Syria; courtesy the ISIS; has also not hampered production to a large extent. Even extremists realize the criticality of oil to their operations. Additionally, Russia has also significantly increased its oil production to record levels after the disintegration of the USSR in 1991. Thus, a significant collective increase in supply of crude oil in the international market would require a concurrent increase in demand. Has that been the case?

Demand Side Dynamics

Unfortunately, that has not been the case. With the growth prospects of the global economy downgraded to 3.8% for next year by the IMF, from a forecasted 5% in July, 2014; the demand dynamics have not been favorable. According to the International Energy Administration, the demand projections for the remainder of 2014 stand at 200,000 barrels per day; significantly down from the initially projected 700,000 barrels per day. Slowing demand from the likes of heavyweight consumers such as China coupled with fragility in the Euro- zone has further diminished demand. If the strongest European economy in Germany suffers an industrial output drop by 4.4% in August-September, 2014; it certainly does not bode well. This has only reinforced concerns over falling oil prices. With the rest of the global economy struggling to achieve any notable growth, there has been a major fall in demand for crude oil. Furthermore, many developed economies, such as Japan, are making a transition towards the more widespread adoption of natural gas and alternative fuel sources in an attempt to pursue a more sustainable path towards development. This further diminishes crude oil demand.

Consequently, there is a major mismatch in supply and demand in the present scenario. Excess capacity and production coupled with dwindling demand have resulted in driving down crude oil prices.

I shall examine the impact of falling crude oil prices on the OPEC member states and the Indian economy in my next article.

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