What is causing the huge drop in oil prices?

As most of you might have heard, oil prices have been dropping remarkably over the past 18 months. During this period, the world’s main benchmarks, Brent (European Oil) and West Texas Intermediate (US Oil) have dropped from over a $100 dollars to less than $30 dollars a barrel. Still, many experts believe that we haven’t seen the bottom yet. Investment bank Goldman Sachs for instance, predicts oil prices to tumble to $20 dollars a barrel in the course of this year. Let’s take a look at the cause of this drop.


Source: www.NASDAQ.com

Most of the experts believe that the lower prices are due to oversupply and fear of an increase in oversupply. Last year the world produced 96.3 million barrels of oil a day, of which it consumed only 94.5 million barrels on a daily basis, an oversupply of 1.8 million barrels. One recent development that has led to fear that this oversupply might increase is the lifting of nuclear-related sanctions against Iran, which allows them to sell oil on the international market again. According to the last estimates, Iran will supply 0.5 million barrels a day, increasing oversupply by roughly 30%. Another big concern is China, who is, after the enormous growth in the past decade, a big importer of oil. Recently, however, the country showed some signals of declining growth which could affect the country’s demand for oil.

Furthermore, none of the oil producers seems willing to decrease supply despite the low prices. Saudi Arabia, for instance, produces as much as it can in an attempt to drive the higher-cost producers such as the United States out of business. This strategy doesn’t seem to work however, since only 6% of the global production fails to cover its operating costs at a price of $30 a barrel. Some producers are facing operating costs as low as $15 a barrel, which indicates that the race to the bottom will not be over soon. Next to the lower costs, producers from several countries also see their revenues increase due to an appreciation of the US Dollar versus many other currencies, such as the Russian Ruble and the Brazilian Real. This allows oil producing countries like Russia and Brazil to get more domestic currency for their barrels, which increases profits.

All in all, rough competition and lower growth forecasts for big economies such as China make it rather unlikely that oil will be back at the price it traded for 2 years ago any time soon.

About this article

Written by:
  • Jasper Bal
| Published on: Feb 15, 2016