It is not a simple answer, but we will start with the obvious. The output of oil has increased substantially with the use of fracking and other technologies. It has increased so much that the United States is now the largest producer of oil in the world surpassing Saudi Arabia! Add to that, the Organization of the Petroleum Exporting Countries (OPEC) has refused to cut production causing an over supply. This is not exactly true. Many OPEC members would like to reduce production, but the largest producer, Saudi Arabia, does not want to lose market share and refuses to cut therefore causing the other members to maintain their production as well. The third leg of this stool is a global economic slowdown, mainly China. With slowing growth comes less need for energy, which exacerbates the oversupply.
Now that we know why the price has gone down, let's examine where the price is going. I heard someone on the news the other day claiming that with the new technologies to obtain oil there will be a never ending supply, and that oil prices will remain in the $20's forever. He is right in that we have increased the amount of oil available to us, but what he doesn't address is the cost to retrieve that oil. These new reserves that we've found do not come cheap. The most expensive oil produced in the United States today comes from older wells known as “stripper wells.” These are aging oil and gas wells that only produce a few barrels per day. The maintenance cost on the wells does not decline with oil prices, and these wells become unprofitable around $40 per barrel. Other high-cost oil comes from Canada’s tar sands and the United Kingdom’s North Sea oil fields. Those become unprofitable around $30 per barrel and $50 per barrel respectively. Obtaining oil through "fracking" can be done for around $25 per barrel, however, it is not profitable to discover and open a new well unless the price is $60 per barrel. I say all of this to let you know that over 30% of the world's oil costs more that $36 per barrel to get it out of the ground.How long can anyone stay in business selling oil below $30 per barrel when it costs you $36 per barrel to get it? Not very long. What happens when that 30% is eliminated, and how will it be made up? The world is producing around 93 million barrels per day. Is it reasonable to assume that the remaining producing countries can increase their production to 28 million barrels per day? I think not.
Perhaps the biggest threat to the low price of oil is economic. Saudi Arabia is the lowest cost producer of oil at under $10 per barrel. But, even at that low cost the country is losing money because their entire economy is based on oil revenues. They have high unemployment, and high subsidies and benefits for its citizens. The main source of revenue for Russia is also oil and gas. The country is bleeding money with the invasion of the Ukraine, and now involvement with Syria. If you watch and listen carefully you can see that Putin is starting to act very nervous. Venezuela's economy is very dependent on oil revenues, and at this writing is close to bankruptcy. There are other OPEC countries that are suffering financially not because of their oil dependence from an energy standpoint, but from an income standpoint. Therefore, I believe that the price of oil will be influenced more by the economics of income rather than by supply and demand.
At the end of the day I see oil prices at $40 per barrel by the middle to late 2016, and rising to $60 per barrel in 2017. As the global economy recovers we will continue to see a rise in the price. After all, it's still a limited resource.
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