Oil Prices

Over the past year, oil prices have experienced the largest drop since the 2007-2009 recession. Throughout the mid-2000s oil prices fluctuated around the psychological benchmark of $100, whilst today it seems that $30 per barrel is the new reality. Indeed, according to market forecasts1 for 2016, companies and investors are preparing for another year of strain.

Figure 1. Weekly crude oil prices: WTI, US$ per barrel Source: U.S. Energy Information Administration

There are several prominent reasons why further drops in oil prices can be expected in the near future. First, this price drop is very different from the demand-induced oil crisis of the recession.

One of the unexpected triggers was caused by OPEC, which increased oil production at the beginning of the drop in oil prices, rather than decreasing it. Meanwhile, producers in the U.S. and Russia proved much more resilient than expected. For example, despite the reduction in U.S. oil production in spring 2015, its annual production level showed multi-decade highs. According to official data, on average since October 2015 the U.S. produced 9.3 million barrels each day. Canada, Russia, China and Norway all are expected to post annual production gains this year, according to the U.S. government's Energy Information Administration.

The second reason is the slowdown of Chinese economic growth, which continued to slow in the third quarter of 2015 and is nearing its slowest pace since the global financial crisis2. The recorded GDP growth rate in the third quarter of 2015 reached 6.9%, the first time since the recession that economic growth in China fell below 7%. This slowdown of Chinese economic growth triggers additional concerns about the world economic outlook.

Finally, the struggle for the market share between Iran and Saudi Arabia may add further impetus to the plummeting of oil prices. Iran is back on the international market following the recent lifting of western sanctions. Furthermore, recent evidence shows that Saudi Arabia has an excess production capacity of 2.5 million barrels per day, which is double the supply it released onto the oil market last year. This may signal Saudi Arabia's willingness to keep up with low prices and foreign reserve cuts to protect its share in the oil market. In addition, Saudi Arabian Oil Co., better known as Saudi Aramco, has recently announced that it is considering the possibility of...