With few exceptions, the last oil price plunge affected the economies of oil-exporting countries in a very negative way. This is why it is important to look into the reasons that led to the last oil price plunge. These reasons may be summarized as follows:
4.1. Influx of Iraq crude oil to the market.
Contribution of the influx of Iraq crude oil is well explained by the chart below
.
Figure 2. Incremental oil production since January 2014
4.2. The US is no longer the biggest buyer of crude oil
The US transition from one of the biggest importers of crude oil satisfying only 70 per cent of its energy needs from domestic sources as recently as in 2005 to 90 per cent in 2014 and to lifting its crude export ban at the end of 2015 became one of the biggest contributors to the current situation.
As you can see from the chart below, the US crude oil production grew from 7.1 million barrels a day in 2013 to practically 10 million barrels a day in the
first half of 2018, which represent more than 40% increase. This is also an important signal for the market and could be a long-term game changer.
Another important point is the psychological effect of this action on the market players.
Figure 3. US Crude Oil Production
4.3. Success of renewable sources of energy
Even though the World now depends heavily on hydrocarbon sources of energy (mainly oil, gas and coal) to meet its energy needs, British Petroleum (2018) informs that “Renewables do, however, play a significant role in the growth of electricity, contributing almost 50% of the growth in global power generation in 2017.
At the individual country level, these sources are already playing an important role in some countries. Denmark leads, with 68% of power coming from renewables. Among the larger EU economies, the renewables share in power is 30% in Germany, 28% in the UK, 25% in Spain, and 23% in Italy.
The rapid growth of renewable power generation continued in 2017, with an increase of 17%. In volume terms, the largest increase in 2016 was in China, followed by the US; with Germany, Japan, and India making up the rest of the top five.”
This is happening mainly because of these three reasons:
1. The costs of renewables utilization are coming down rapidly making them more commercially attractive for end users.
2. The utilization of conventional energy sources based on burning fossil fuels has a negative impact on the environment.
3. Another problem with these sources of energy is that they are not renewable. The more they are extracted, the more they are becoming expensive to retrieve.
As a result, the utilization of green or renewable energy sources, which are continuously replenished and do not give an adverse impact on the environment, is constantly growing. The growing use of renewables deliver a very important message to all the market players forming their expectations of further oil prices fluctuations.
4.4. Development and introduction of new technologies
Technological development has profoundly affected costs, quality and environmental impact of energy generation. A good example for this is the development of new technologies, which made the production of shale oil and gas commercially attractive. This allowed the USA to again become one of the largest oil and gas producers. The inflow of shale oil to the market has become one of the main reasons, which led to the oil price plunge of June 2014. There are so many other new technological developments, which affected the market.
They include, for example, the combined-cycle gas turbines (CCGT), cogeneration of heat and power in modular, small-scale energy systems, wide-spread application of information technologies, etc.
And there is much more to follow. Future energy options may include controlled thermonuclear fusion, fuel cells, etc.
4.5. Success of energy efficiency and energy conservation efforts
Another very important and often omitted factors are energy efficiency and energy conservation. As rightly mentions Stephan Kohler, president of German energy agency Dena, these aspects are the "most misunderstood of the energy transition, and yet the ones that work best.” Other countries also provide excellent examples: California’s efficiency success has avoided the amount of power needed from 30 power plants thus far and is expected to avoid another 11 power plants’ worth of electricity over the next decade because cutting energy waste reduces the need to generate power from fossil fuel power plants.
4.6. Expected influx of Iran crude oil to the market
The influx was expected after lifting the sanctions imposed by the United States, European Union and United Nations. The sanctions were actually lifted on 16 January 2016 in exchange for curbs on Iran's nuclear program, but discussions of this possibility started earlier and seriously contributed to the negative oil price shock expectations. Possessing huge reserves of quality crude oil, Iran, which was several years ago pushed from the international markets out, was and is very keen to get back its market share.
Market players were expecting that in order to achieve this goal the country would apply dumping strategy pushing oil prices further down. It did not happen because the relations between the USA and Iran remained strained and in May 2018 President Trump announced that the USA quits the Iran nuclear deal.
4.7. Slowdown of China’s economic development
This is a very important factor, which actually raises red flags for the global economy. There were a growing number of pessimistic forecasts of China’s further economic development. For instance, in 2014 Fitch rating agency warned that a sharp slowdown in China's GDP growth rate to 2.3
percent during 2016-2018 would keep commodity prices low for longer than expected period of time. This forecast did not materialize either. Vice versa, in January 2018 the International Monetary Fund raised its forecast for China's economic growth in 2018 to 6.6%, up from the 6.5-percent prediction made in October 2017.
4.8. Political instability
Growing political instability in the world, which initially pushed oil prices up, then forced oil importing countries to reduce their dependence on foreign energy supplies. This is yet another market driver and yet another expectation, which decreased global oil prices.
In any case, we should not underestimate the uncertainty of the oil market, which has many times shown that most of expectations regarding it behavior appear to be wrong. This issue has been studied by many authors, for example Allsopp and Fattouh (2011) point out that “In the longer term, the uncertainties remain very great, especially since the tensions between a realist view of likely energy-market developments and the imperatives of the climate change agenda remain unresolved”, but the current paper does not concentrate on this issue. The same view is shared by US Energy Information Administration (2016) “Expectations for future world oil prices are another key source of uncertainty in the IEO2016 projections” and Baumeister and Kilian (2016a) “Although our understanding of historical oil price fluctuations has greatly improved, oil prices keep surprising economists, policymakers, consumers and financial market participants.”
In normal times, the broad effects of the oil price drop on the global economy are well known. It should act as an international stimulus that will nevertheless redistribute heavily from oil producing countries to consumers and the longer the new prices endure; the more profound will be the effects on the structure of industries across the world. Examples of such effects may be the increase of global economic growth and removal of fossil fuel subsidies.
But this time, economists are actively debating whether the world has changed and other moving parts - such as falling inflation levels and the strong dollar - will affect the usual economic relationships. This time there are more voices than usual suggesting expectations of a global boost are deceptive.
“Stephen King, chief economist of HSBC, believes lackluster demand in China, Japan and Europe over the summer of 2014 was the primary cause of the collapse in prices so the traditional “lower oil prices good: higher oil prices bad” story is “no longer so obviously true”. He then argues that optimism following an oil price fall in economic estimations is based on positive supply-side developments for the western developed world, but “there are plenty of situations where falling oil prices are merely symptoms of a wider malaise”5. There is one more, probably the most important point to be taken into consideration: we have mostly extracted the cheapest-to-extract oil. It takes more and more human efforts, capital, etc. to produce a given number of barrels of oil equivalent. It is expected further growth of oil production costs in the future. However, the uncertainties surrounding the oil market prevent from making any serious projection about oil prices.
5 https://www.ft.com/content/3f5e4914-8490-11e4-ba4f-00144feabdc0