Oil Economics (1/9/2015)

The price of oil has dropped by about 55% in the past year, causing a great deal of disruption. The economies of many oil producing countries are being devastated by the drop. The cost to produce the product has become greater than the selling price in many places, resulting in an economic imbalance. To mitigate this price drop, a reduction in staffing and production by oil companies might help, but in third world countries, a significant reduction in employment could result in some form of uprising. Even in a large country like Russia that is very dependent on the sale of oil, the impact of this price change is resulting in a severe downturn in the country’s economy. In the U.S., which prides itself on being market driven, the layoffs have begun, with various states such as Louisiana feeling the pinch in employment and in state and municipal tax revenues.

In most developed countries, the reduction in oil prices has allowed consumers to spend more on other things they want. It has also helped reduce costs by manufacturers that use large amounts of energy. This then allows manufacturers to become more competitive and/or to increase profits. Geopolitically, this change has had the effect of diminishing Russian dominance of fuel supplies in Europe and thereby further eroding the relationship between many European countries and Russia, hurt when the Russians marched into the Ukraine.

Oil prices are likely to remain low for some time, as the worldwide supply was jolted with the introduction of new supplies through fracking. While fracking is more expensive than the cost of Saudi Arabian oil production, production can be reduced or stopped when prices are down and increased as prices rise. This elasticity should put a limit on the increasing price of oil for some time to come. Hopefully, many countries that are in an economic downturn will get better and need more commodities to support expanding economies. When this happens, we may see pressure on oil prices. For now, here in the U.S., for Americans located in non-oil producing states, low oil prices at the pump and for home heating oil are a positive development.

Ed Mallon

January 8, 2015