What goes up…

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onfused by news coverage around the collapse of oil prices?  You’re not alone. Oil markets are complicated, even at the best of times.  Here, Energy Exchange takes on three basic questions to cut through the noise.

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Why have crude oil prices fallen so low and what was behind their rapid decline?

The collapse of crude oil prices last fall was nothing short of spectacular, tumbling 50 per cent between midsummer and the end of the year. But should it have come as a surprise? Maybe not. While the scale of the retreat was startling, oil basics suggest prices were due for a correction. The reason? According to Kevin Birn, a director at IHS Energy in Calgary, oil production simply outstripped demand. “It’s fundamentals,” Birn says. “There’s just too much oil on the market.”

Several factors have shaped the current scenario. The “shale revolution,” for example, has seen U.S. shale oil production quadruple in the past three years to about four million barrels a day, according to Bank of Canada statistics. Meanwhile, fears of political unrest in some oil producing countries have abated, with anticipated disruptions in production failing to materialize.

Such factors — and many others, such as a robust U.S. dollar, which has depressed the buying power of other currencies — have played out against a backdrop of sluggish global economic growth, weakening oil demand worldwide. Indeed, oil prices were already in decline in November when OPEC, a 12-country alliance that accounts for almost one-third of global oil production, sent them into a tailspin, announcing it would maintain production levels. With that one decision, OPEC changed gears on its longstanding practice of adjusting output to stabilize prices, a move that has been interpreted as an effort to maintain market share in challenging times.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column width=”1/1″][mk_blockquote style=”line-style” font_family=”none” text_size=”22″ align=”left”]Several factors have shaped the current scenario. The ‘shale revolution,’ for example, has seen U.S. production quadruple in the past three years to about four million barrels a day, according to Bank of Canada statistics. Meanwhile, fears of political unrest in some oil producing countries have abated.[/mk_blockquote][mk_padding_divider size=”40″][/vc_column][/vc_row][vc_row][vc_column width=”1/4″][vc_column_text disable_pattern=”true” align=”left” margin_bottom=”0″]

Why does no one know when oil prices will recover?

Oil prices are like the weather: there are so many moving parts, it’s hard to reliably predict what will happen. “Any kind of forecast is based on our best available knowledge,” Birn says. “Bumps along the road are hard to predict.” Moreover, oil trades globally, so issues in one region move quickly throughout the entire system.

But even though no one knows when recovery will come, there is one point of consensus: while oil prices may stabilize in the near term, they won’t climb anytime soon to levels we saw only a year ago.[/vc_column_text][/vc_column][vc_column width=”3/4″][mk_image src=”http://www.energy-exchange.net/wp-content/uploads/2015/05/Outlet-Primer_EESummer152crop2.jpg” image_width=”460″ image_height=”651″ crop=”false” lightbox=”true” frame_style=”simple” target=”_self” caption_location=”inside-image” align=”right” margin_bottom=”10″][mk_padding_divider size=”40″][/vc_column][/vc_row][vc_row][vc_column width=”1/1″][vc_column_text disable_pattern=”true” align=”left” margin_bottom=”0″]

How are oil prices determined, anyway?

Crude oil pricing is subject to many forces. But the main factor is supply and demand. Prices go up when supply drops and fall when supply is plentiful.

That fundamental relationship, however, is not as simple as it sounds. One key issue is that oil trades on futures markets, where buyers and sellers enter into contracts to deliver fixed volumes on specific dates at agreed prices. The driving force in those contracts is whether traders think prices will rise, fall or remain stable. Thus, speculation enters the pricing process.

For example, consider this question: Why didn’t oil prices fall sooner? The conditions certainly existed. According to the International Energy Agency, oil supply started exceeding demand in the later months of 2013. Yet oil prices continued to trade in a relatively stable band between $90 and $110 that they had been enjoying for an extended period. Part of that stability came from a belief that while political unrest in countries such as Libya and Iran threatened to disrupt supplies, growing domestic production in the U.S. would offset challenges. By the late summer of 2014, however, it became evident the political risks were not as big as anticipated.

The market view of supply and demand changed, and prices began to erode.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column width=”1/1″][mk_padding_divider size=”40″][mk_button dimension=”three” size=”large” outline_skin=”dark” outline_active_color=”#fff” outline_hover_color=”#333333″ bg_color=”#13bdd2″ text_color=”light” url=”/resources/energy-exchange-magazine/issue-4/” target=”_self” align=”left” fullwidth=”true” margin_top=”0″ margin_bottom=”15″ animation=”scale-up”]Read more stories from the Summer 2015 issue of Energy Exchange magazine[/mk_button][/vc_column][/vc_row]