In 2008 during the height of the Great Recession, the price of oil reached $147 per barrel. Today, that price is hovering around $60 per barrel. The two questions I hear most often are, “Why is this happening?” and “Will the freefall continue?” I can try to answer the first question. As to the second question, let’s just say I keep my distance from forecasting the future.
The price of oil is generally determined by the value of the U.S. dollar and demand and supply of oil. Currently, both measures are volatile. When the dollar is strong against foreign currencies, foreign products we import are cheaper, which results in a trade surplus. It’s also cheaper to travel internationally because the dollar goes further to purchase hotel rooms, rental cars, and postcards. Conversely, when the dollar weakens, oil prices rise.
At the same time, domestic demand for oil from OPEC (Organization of the Petroleum Exporting Countries) countries has dramatically declined. The increased number of hybrid and electric cars on the road plus our focus on conservation plus the increased production of hydraulic fracking from shale basins has yielded a 60% decrease in oil imports since 2008. Petroleum experts are forecasting an oil trade surplus, meaning we’re exporting more oil than we’re importing, by 2020, only four years away.
Even with the lower demand, the OPEC cartel is still producing oil at a very high rate. The basic law of microeconomics is that when demand is low and supply is high, prices will come down, which is where we are now. The OPEC countries are betting someone, maybe China, India, Indonesia, or another country with a fast-growing economy, will buy their oil. In the meantime, those countries whose revenues are almost 100% dependent on oil sales are starting to feel the effects on their economies, while we benefit by filling our gas tanks cheaply. Manufacturers’ net income grows because their transportation costs are lower due to the lower gas prices.
We are in the midst of a torrent of oil price volatility which may last several years. However, when the smoke clears, the United States will be energy independent with more predictable gas prices at the pump and a healthier economic system for all of us.
David M. Green