Oil Price Falls and its Impact on Economies and the Consumer


The price of crude oil internationally has fallen - from a high of $120/bbl as recently as July 2014 to $35/bbl . A 70% fall in less than two years, ‘Precipitous’ is the only word to describe such a collapse.

Global oil production has increased by nearly 10 million barrels per day to 97 million barrels per day, or just over 10% in the last four years. This compares to a 5 million barrel per day increase or a 5.5% rise in global crude oil demand. Furthermore crude oil supply is expected to keep rising especially after the recent deal between the US and Iran that allows Iran to sell its oil on the global market.

OPEC as the Organisation of Petroleum Exporting Countries has always acted in concert to support the price of oil by limiting crude oil output when necessary.  It consists of thirteen members including Angola, Nigeria, Libya and Algeria from Africa. As a collective the OPEC countries produce approximately 30 million barrels a day out of 95 million barrels a day that is utilised for global production, in essence their production amounts to nearly a third of the world’s production.

The de facto head of OPEC is Saudi Arabia, the world’s largest crude oil producer with production of just over 10 million barrels a day.  Since 2014 Saudi Arabia, has signaled to the market that it will no longer act to cut oil output as a way of supporting the price of oil. It ‘s evident that the Saudi’s are fighting for market share.

The United States has implemented groundbreaking technology and innovation to extract oil out of what is known as shale rock formations largely found in the Eagle Ford oil fields of South Texas and North Dakota’s Bakken region. This new shale oil that America has uncorked now results in US production being ramped up from 5.5 million barrels per day in 2012 to a recent peak of 9.7 million barrels per day; thus the US is now technically a net exporter of oil. In response, the Saudis have negated any notion of decreasing oil production, with the aim of driving shale out of the market.

How does a low global oil price assist the Saudi’s in driving out shale production out of the market?

It all boils down to economics of production costs. Saudi Arabia produces a barrel of oil for $6-$7/barrel while shale has a production cost of anywhere between $35-$60/bbl depending on the operator. So by leaving the oil spigots open and not cutting oil output the Saudi's keep oil prices down at such a level that US shale oil is no longer commercially viable, thus curtailing any prospects of expansion.  It's a royal rumble amongst the big boys.

How do all these machinations impact the man on the street?

The most obvious route the man on the street is impacted is via fuel service stations. A barrel of crude oil can be refined into 190 litres of petroleum product such as petrol, diesel, paraffin etc.

So if 1 barrel of crude oil produces 190 litres of refined petrol. Then it means that at an oil price of $35/barrel, a litre of crude oil costs just 18 cents.

There are a number of reasons that determine why petrol prices are sticky downwards and fall slowly even with a significantly low crude oil price:

THE MAIN REASON - is down to one of the two certainties in life – and that of course is ‘TAXES’. Governments the world over add a plethora of taxes and duties to the cost of fuel and these taxes are based on a $/litre and do not change even when crude oil prices are falling. In most countries, govt. duties and taxes today make up more than 80% of the cost of a litre of unleaded petrol.

Another factor - is that the process of converting crude oil into petroleum products such as petrol, diesel, paraffin, kerosene etc, known as refining, comes at a cost. The cost of refining does not change merely because the price of crude oil has fallen.  Fuel is also transported by pipeline, road and rail from the ports to various destinations.  These transport costs do not fall even though the price of crude oil on the world market has fallen.

In light of these combined factors it does not necessarily mean that a fall in crude oil prices will result in a proportional decrease in the price of petrol and other oil based products.

The economic impact of falling oil prices for the consumer, means that there is lower inflation and higher real disposable income.

As ever there are always winners and losers in any market movements. (The market can look like a zero sum game – show me a winner in any market and I’ll show you a loser in the same market crying into this/her warm beer.) Oil majors are reporting relatively lower financial earnings and are having to put new projects and expansion on hold. Share portfolios that had invested in oil companies on the stock market have also been negatively affected; however, consumers are benefitting from lower prices at the fuel service station pump.

The impact on African oil producers:

A big fall in the price of oil results in a significant fall in local government revenue. The most egregious example of this in Africa is Nigeria; Nigeria has had to go cap in hand to the World Bank and other lenders to secure a $3.5 billion loan to help finance their $30 billion planned budget. Their budget for 2015 was predicated on an oil price of $65/barrel, so the current oil price implies a big hole in Nigeria’s budget. Other African nations such as Ghana had gorged in advance, borrowing and spending in the expectation of huge oil windfalls tomorrow - these windfalls may now not materialise. So we are seeing oil producing countries in Africa seeing their currencies take a hammering and their cost of borrowing going up even as the cost of fuel falls for the consumer on the street.

How low are the oil prices likely to fall and what is the prognosis for a recovery:

We’ve likely already seen the bottom in terms of the price of crude oil; it reached $28/bbl earlier this year and is unlikely to go lower. It is likely to consolidate around $40/bbl this year and head towards the $50-$60 range over the next couple of years. US shale oil producers are starting to feel the pinch with bankruptcies in the US oil sector at their highest level since 1997. So the Saudi strategy is working. However, even the Saudis at some point will have to blink  - they too have social budget cost issues to worry about and that means they cannot hold oil prices low forever. We should soon see oil prices start the long trek to recovery but we wont see the heady heights of $140/barrel for some time yet!