The journal Economist (Jan 23-29) has recently published an article about costs of oil production: Who's afraid of cheap oil? At current price $30-35 it is profitable to have long run production only for Saudi Arabia, Kuwait, Iran and Iraq. Even Russia should not produce because its full cost is about $50. For shale oil of USA and tar sands of Canada it is almost $70. This is not sustainable in the long run, since there are not enough reserves to satisfy this price. A very popular story is that Saudi Arabia wants to kick out US from the market, and then to raise price. Another theory (of more conspirological origin) is that this is a game to destroy economies of Venezuela and Russia, but economic mechanism of that game was not specified.  American oil industry is also worse off, but not US in general because they are more consumers than producers. OPEC does not seem to play role similar to those of 1970-80s due to high disagreement between Saudi Arabia and Iran, and cannot return prices to normal level.

In essence, the end of quantitative easing by the US Federal Bank - it caused a relative crash in commodity prices as the dollar became stronger relative to other currencies, at the same time starving key investors in emergent markets from extremely cheap capital (i.e. money). At the time the FED decided to stop quantitative easing and increase interest rates, the O&G industry had accumulated excess capacity (in an economic point of view) and production.

Oil and Gas were not the only commodities crashing in 2015 - a crash that was long expected, by the way. These are part of the 6-7 year 'super-cycles' that commodities often experience.

Best wishes, Tiago

Tiago, in fact you are saying that financial market has overrun exchange economy - the one for which all equilibrium theory has been established starting from Arrow and Debreu. There is a good recent movie with Brad Pitt "The Big Short" - about origin of subprime crisis; see https://en.wikipedia.org/wiki/The_Big_Short_%28film%29 .  While in 1980s OPEC could influence price with cartel agreement, but now nobody of producers can do that. Because there is higher stock of money produced by Fed by printing dollar - and sometimes it creates bubble and in other times ruins commodity market?

Oil price decrease has no economic explanation, as it is politics. The invasion of eastern Ukraine and annexation of Crimea is definitely one of the main reasons behind the sharp decrease in oil prices. This took place at a time when the price of oil was above one hundred dollars. The USA and NATO could not accept the Russian aggression, which is not acceptable indeed, hence; something ought to be done, hopefully not military. NATO had learned a historical lesson during the cold war; the economy is the best battle ground. Remember that it was precisely on that ground the West dismantled the Eastern block and the Soviet Union. Things became even worse, given the Russia decision to carry out air strikes over Syria in support of its long-time ally, Bashar Assad.  

Ahmad, if politics is done using economic tools, the micro mechanism of those tools should be explained. There is a theory that USSR has been destroyed due to low oil price. But the big question is how markets can do that. For example, it seems easy for OPEC to get together and cut oil production not by 5% but by 50%! Price will jump then above $100, and all will benefit. Why they do not do it? US shale firms are also in deep crisis now. Saudi Arabia (if it is the only interested part) also has huge budget deficit. Russia can easily turn its production to domestic use - for cheap transportation over its vast territory, or just keep oil in ground for future generations. What force is making these parties behaving as they do now - to push price down to non-acceptable $30 for anybody?

All these are interesting ideas and open questions. Thank you all for sharing them.

One point companies have not mentioned, coming back to my previous reply, is the fact that the dollar is now worth well more than after the sub-prime crisis (2008-09). $32 at present is worth substantially more than $32 by that time - surely this is another way of making companies balance their books with current oil prices?

A parallel point is that over-supply can also be explained by reduced profit margins. OPEC does not have the power to control prices because producing countries need to maintain their net profit in with ever-reducing margins. This same behaviour happened in the North Sea c. 1999 when the barrel was close to $11 - the UK never produced so much oil and gas in its history.

Dear colleagues, according your ideas I understand that this problem is no a technical problem so it is related to global policies. Thus I understand that it is only an a forced crisis by some interested stakeholders because oil prices are a weapon to destabilize local economies. Therefore it is only a temporary break down of a tendency of rising prices. So... for how long we will have these low prices?  I found this NY paper that give some ideas about the characteristics of this crisis.

Thanks a lot for your interesting ideas!

http://www.nytimes.com/interactive/2016/business/energy-environment/oil-prices.html  

Dear Alexandre, just watch this movie "The Big Short" and you will understand  what difficulty might have a valid economic theory against the supported policy.

If you would like to know my personal opinion about correct trend in the price of hydrocarbons - just read this paper: https://www.researchgate.net/publication/272380285_About_Origins_of_Financial_Crisis_2008

I have to add that there is widespread belief about fast substitution of oil by renewable energies. However, even at the prices of $100 it was rather slow and will definitely slow down today. At the same time, oil resources are globally finite and peak oil should come. It probably came already in conventional oil, but not yet together with non-conventional. That is why long term price trend should be positive - until break-through discovery in alternative energy.

Conference Paper About Origins of Financial Crisis 2008

 Dear Yuri, thank you very much for your paper and your ideas, I just downloaded it. I read the conclusions and I could understand them (I am not used with vocabulary related to economic topics). I will read it with interest.

From the top of my head, here are a few reasons that have contributed to lower oil prices:

There are definitely many more reasons, but in my opinion, those can account for most of the price drop.

Dear Ian,

Thank you very much. Only one thing...  what does mean production of unconventional oil?  Is it only related to new drilling forms or to oil extracted from oil shale rocks, too?

Thank you very much!

Ian, those reasons are clear to me. But I do not see rationality among producers. If we believe full cost data from Economist (I cited article), shale oil is (long run) dead at $60, and there is no reason to move prices to $30 (this brings budget deficit to all producers!). It is well known that oil demand is inelastic, so cutting quantity by x% will increase equilibrium price by much more than x% (let say, nx, n>1), and for the revenue, R=(1-x)(1+nx), the derivative dR/dx>0. Given that OPEC currently controls about 40% of oil supply (but much higher share of reserves) the reaction of price on their production cut will be less than price elasticity. However, given than n is probably larger than 3, the influence on revenue will still be positive. Profit, pi=R-C also grows even under assumption of zero cost (which is wrong), and thus it grows even faster. Hence, keeping quantity so that price is just below $60 is an optimal decision for cartel of producers (OPEC) given that they want shale oil of US out of the market in the long run.

And we have observed this stabilization some months in 2015, but then prices went down crazily. To be clear, I attach the graphs of oil price dynamics, share of profitable oil at $30 from Economist and cost curve for different producers from IMF (found at http://www.simontaylorsblog.com/2015/01/18/the-oil-price-and-short-and-long-run-supply/ ).

Alexandre: "Unconventional oil" usually refers to shale oil, tight oil and oil sands.

Yuri: Yes, I think you are right that the picture may be more complicated. You point out the two aspects that are bothering me too: firstly, why are producers apparently producing oil at a loss? And secondly, why does OPEC not enforce stricter quotas to raise the price?

The short answer to both questions is, of course: I don't know. But I have a few suspicions.

Now, why are producers apparently producing oil at a loss? I see a few possible explanations. Firstly, they might not actually be producing at a loss: I have heard some speculate that unconventional oil has become significantly cheaper to produce than most believe. Secondly, some fields may be producing above their short-run marginal costs but below their long-run marginal costs: they need to recover the initial large investment in developing the field. Thirdly, oil companies believe the price will rise soon and don't want to incur the costs of mothballing/restarting their infrastructure and workforce. And lastly, in a downturn economy some governments cannot easily fire a large number of employees without further hurting the economy (think national oil companies such as PDVSA).

Why does not the OPEC cut quotas and raise the price? They still control a large part of the oil production, but I think their power is declining. Firstly, accessible shale oil reserves have dramatically increased lately, and so OPEC now controls a smaller share of total oil reserves. Secondly, cartels are unstable (that is, it is not a Nash equilibrium -- a classic game theoretic result) and the incentives to cheat increase with the price, and the OPEC member states are currently economically pressed. I think even OPEC realises that it would be extremely difficult in current economic conditions to enforce stricter quotas.

Those may be some of the possible reasons, but there is no way to know for sure. But the price is what it is, so there must be some explanation, right?

Dear Alexandre Ribó 

Greetings,

Please find the attached file about your topic may be interesting for you,

Best Regards

Supply has exceeded demand. Excepting the US, the global economy is still on the doldrums. China Has recorded lowest growth in 30 years and Japan is still fighting deflation.  Meanwhile Iran is back in business and the US is refining its own oil, thanks to new technology. It is great to see that the forces of demand and supply actually work.

Dear Faris Alshubiri,

Thank you very much for your complete paper, I will read with attention.

Best regards