What is Going on with Oil Prices?!

As you might expect, it’s complicated. Oil is a global commodity, and the price of it affects nearly everything we purchase and consume. And you have probably heard that it is dropping like a sky diver whose shoot won’t open. Is this true, how bad is it, and most importantly, why?

First, I should state I am not a commodities analyst, but today I will pretend to play one. Let’s first consider where the price of oil has been, and where it is now. Most oil in the US is tracked by the index for West Texas Intermediate (WTI) oil. In the last twelve months, WTI peaked at nearly $100/barrel and has since fallen into the mid $50/barrel. While swings like this are not unheard of, the last time WTI was around $50/barrel was back during 2009 in the depths of the recession. Also, this really hasn’t been so much a price swing as it has been a gradual 6-month decline.

The decline in price, as far as I can tell, can be tied to three things: Supply, Demand, and Currency. The supply of oil right now is ample, and this has much to do with fracking revolution. Now that many new oil fields in North Dakota and Texas have been developed due to fracking, there is more oil production in the world. This comes at a time when demand is pulling back, because globally, most of the world’s countries are not growing as much as previously anticipated. China, Japan, and the European Union are all experiencing sub-par growth, so their energy needs are not growing as rapidly as forecasted.

That leaves us with the last issue, currency. The one major piece of the global economy that is growing is us! The United States is finally realizing nominal growth, not seen since 2009. This is impacting our currency, in particularly, driving up the price of the dollar. The dollar is currently crushing the other major world currencies, and the strength of the dollar is returning to a pre-2009 level when compared against the Euro or the Yen. Why does this impact oil prices? Oil is priced in dollars, and so when the dollar is strong, it buys more oil!

Fear mongers are abound, screaming the price of oil may hit $40, no $30, no $25 dollars a barrel! While they have no evidence to support their claims, they sure get plenty of attention, like someone shouting “fire!” in a crowded movie theater. The facts are, the price of oil seemed to be quite expensive in the past 5 years as it hovered around $100/barrel. Fracking technology supplied the world with additional oil, and yes, there was great incentive to do so at $100/barrel. And as we know in economics, more supply will push down prices.

But, logic would also seem to indicate that fracking isn’t going to oversupply the market until fracking isn’t feasible. Rather than seeing fracking disappear, the price will balance out fracking production so it is done efficiently and deliver oil at a price the market will tolerate. This isn’t a bust in the traditional sense, because the oil isn’t drying up; there is just too much of it all of a sudden.

This is bad news to weak companies who were only in the game because of the high prices and could only live off their cash flow and not their own equity. Other companies, which have made more wise investments, will still be able to produce at some price between $50 to $100 a barrel, and they have the financial strength to sit back and wait for the market to figure it out.

It appears the “rush” may be coming to a close, but the fracking and oil production is here to stay. Now the maturing Bakken oil fields will come to settle into their niche in the global market, and this market correction may give wary North Dakota and Montana communities a little time to catch up with their growth.