At the beginning of this week, Reuters reported that oil prices had fallen about 1%. The last year has seen crude oil prices gradually creeping up from a low of around $36 a barrel last spring. For the last few months, the price of a barrel of crude has hovered around the $55 mark – around half the price that it averaged between 2012 and 2014. Is this week’s fall a minor blip or a signal of further trouble to come? What does the future hold for oil prices and what effect will they have on the energy sector?

Supply and Demand

At its simplest, the price of oil is dependent on the economics of supply and demand. When more oil is being produced than demand calls for, prices fall. When demand outstrips supply, prices rise. A complicating factor is that a lot of oil is brought and sold by commodities traders. A big company that uses a lot of oil can buy their future usage supply at a fixed rate – these commodities are known as futures and it makes sense in terms of planning for both the oil producers and the buyers. Speculative traders also buy futures in an attempt to make money from changes in oil prices. However, the act of buying alters the price by increasing demand.

Fixed Production Costs

It is cheaper to pump oil out of the ground than to extract it from beneath the sea. Both are cheaper than extracting from shale, but the cost of this newest technology has started to fall. The powerful Organisation of Petroleum Exporting Countries (OPEC) – that includes Saudi Arabia, Iraq and Venezuela – would normally limit a drop in the price of crude oil by reducing production. However, this time around they have allowed prices to stay low in an attempt to stop tar sands extraction from becoming profitable. The fixed production costs of OPEC are about $20 a barrel. The cost of tar sands extraction is more like $50 a barrel. If the companies exploiting the potential of shale go out of business, then OPEC will have less competition.

Future Fluctuations

As long as OPEC refuse to cut production, oil prices will stay low, but there is too much at stake for them to allow oil prices to become unprofitably low. With big companies based in non-OPEC countries such as America and Canada stepping up their investment in shale oil production (buying up the smaller shale companies that have gone bust due to the OPEC policy of continuous pumping), there’s going to be a lot of cheap oil around for a while. 

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