Wednesday, January 21, 2015

Falling Oil Prices

I have had to make a few trips between Chicago and Evansville, IN, so I'm happy that gas prices are now less than half of what they used to be about a half-year ago. But I have been confused by why did they fall just recently and by such a significant amount because fracking has gradually increased the supply of oil over the last several years. I have heard of the new wells in North Dakota and West Texas. And I have seen several wells drilled in southwestern Indiana about a year ago.

The Jan. 21, 2015 Business section of the Chicago Tribune provides a theory that makes sense. Melissa Harris reports that economist Austan Goolsbee argues the prices are fallen because of decreased demand for oil by China because of their cooling economy.

The article identified three forces on the supply side.
  • Civil wars have not reduced production. Production resumed in Libya in mid-2014 and Iraq set an oil production record in December.
  • Fracking has increased US production so that it is again the leading producer of oil in the world.
  • Saudi Arabia has not cut its production. By letting the prices fall, it is reducing its revenue. But it has $908 billion in reserve. Iran has no reserves. So allowing prices to fall reduces the amount of money Iran has to pay "to keep the Assad regieme afloat in Syria." It also reduces Russia's funds for meddling in Ukraine.
The article ends with a quote of Goolsbee:
But the puzzle with that is oil didn't become suddenly abundant. But the price did suddenly fall. That's why I think it's got to be more caused by a sudden drop in demand or expectations of what demand is going to be in the near future.

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