Collapse in oil, gas prices boosts US, consumer economies; casts pall on oil patch

NEW YORK, N.Y. – For the first half of 2014 the oil market looked just as it had the year before — and the 2 years before that. Oil was over $100 and drivers in the U.S. were paying around $3.50 for gasoline.

Economies around the world seemed to have adjusted to higher priced oil and oil companies were using high profits and debt from willing lenders to scour the world for new reserves.

There was no real hope or expectation that U.S. drivers would see a price at the pump that started with a $2 ever again.

Then, despite intense turmoil in the Middle East and an improving economy in the U.S. — things that have historically sent oil prices soaring — the price of oil went into a nosedive. In the second half of 2014, it dropped by half, to depths not seen since May of 2009 when the U.S. was in the Great Recession. By December, some drivers even saw a price at the pump that started with a $1.

WHAT HAPPENED

Oil reached a high for the year of $107 in late June after Islamic State fighters in Iraq seemed poised to threaten Iraq’s southern oil fields and disrupt supplies from OPEC’s second largest exporter. Then, as Islamic State’s advance was halted, and Libya ramped up its production, oil began to drift lower.

Oil slipped further in the fall as signs emerged that global demand was weakening. The plunge accelerated in late November when OPEC decided to keep producing the same amount of oil despite the low demand.

WHY IT HAPPENED

Oil production in the U.S., Canada, Iraq and elsewhere had been climbing for several years, but rising demand in China and other developing nations along with sporadic outages around the world kept supply and demand in balance.

The price of oil remained remarkably steady, near $100 a barrel, for nearly four years. But U.S. oil production surged far beyond what even the most optimistic forecasts predicted. By the end of 2014, U.S. drillers were producing 9 million barrels of oil per day, up 80 per cent since 2008 and the most in 3 decades.

At the same time, growth in demand for oil began to weaken. China, the biggest single source of oil demand growth in recent years, saw its economic expansion begin to slow. Japan slipped deeper into recession and Western Europe’s economic struggles continued. The U.S. economy — the world’s biggest oil consumer — grew nearly 4 per cent over the summer, but efficiency measures and changing demographics in the U.S. are reducing demand for oil.

With rising global supplies and weak demand, prices dropped.

WHO WINS

Drivers, shippers, airlines and other consumers of fuel around the world are benefiting from sharply lower prices, and importing countries are benefiting from improving trade balances.

U.S. drivers are paying $2.38 a gallon for gasoline on average, the lowest since May of 2009. A typical household will save $550 over the course of the next year because of lower prices.

Diesel and jet fuel prices have also plunged, helping boost the profits and share prices of airlines and shippers. The Dow Jones Transportation Index was up 23 per cent through late December, compared with a 13 per cent gain for the broader U.S. market.

WHO LOSES

For oil companies, oil-producing states, and oil-exporting countries the oil price plunge has been excruciating.

Oil companies generally continue to produce oil from wells they’ve already drilled when prices fall. But sharply lower revenue forces them to cut spending on new exploration projects, makes it harder for them to raise money, and worries lenders and investors that they won’t be able to pay off debt. BP announced last week efforts to trim $1 billion in spending next year. Analysts say that could result in thousands of job cuts.

States that rely on taxes from energy production such as Alaska, North Dakota, Oklahoma and Texas will see lower revenues and some have already trimmed budgets. Major oil exporters such as Iran, Iraq, Russia and Venezuela rely heavily on revenues from state-owned oil companies to run their governments and are struggling under major budget shortfalls.

WHAT’S NEXT

The past year is a reminder that predicting the price of oil is all but impossible, but global supply and demand balances point to low prices sticking around.

OPEC, for example, expects the world to need 28.9 million barrels of its oil per day next year — yet production target is 30 million barrels per day. More oil on the market than consumers demand is a recipe for low prices.

A weak global economy would reduce demand still further, and create an even bigger oversupply of oil. An improving global economy — perhaps helped by the strengthening U.S. economy — could push demand higher, and sop up some of the excess supply of oil.

And lower prices will force investor-owned drillers to cut spending to protect profits, which will eventually reduce output. OPEC also could decide to trim production, either officially or unofficially, to prevent further price declines.

Jonathan Fahey can be reached at http://twitter.com/JonathanFahey .