How Far Will Oil Prices Fall?

With oil prices continuing their precipitous fall in recent days, speculation is mounting that oil prices could continue to fall in the weeks and months ahead, resulting in oil prices that are far lower than anyone expected just a few months ago.  This week, oil prices in the United States (West Texas Intermediate) fell to just $48 a barrel (55% below their 2014 peak), while Brent Crude prices fell to $51 a barrel.  This sharp fall in oil prices is shaping up to be the most significant economic development of early 2015 and it will have major repercussions for the global economy in the year ahead.

It had been expected that, when oil prices fell to around $55 to $60 a barrel, Saudi Arabia and other oil producing countries would react to prevent prices from falling further.  Instead, Saudi Arabia has, through its recent policies, clearly signaled that it is in favor of oil prices falling even further in the weeks and months ahead.  For example, Saudi Arabia’s recent decision to resist calls for it to cut oil output signals that it is prepared to live with lower oil prices.  Moreover, Saudi Arabia appears more interested in preserving its share of global oil markets rather than its oil revenues, as evidenced by its recent decision to cut oil prices for European markets.  This is due largely to the fact that Saudi Arabia is increasingly concerned about the rapidly expanding oil industry in North America and is using its production cost advantage as a weapon to deter investment in the shale industry in the United States and the oil sands industry in Canada, two places where production costs are significantly higher than in Saudi Arabia.

If Saudi Arabia continues to pursue its current oil policies, oil prices will continue to fall in the coming months and could fall to as low as $20 a barrel.  This is due to a number of factors.  First, oil output in the United States and Canada will continue to rise, as Saudi efforts to stem the growth in the oil industries in these countries will only have an impact over the longer-term.  In fact, as Saudi Arabia refuses to cut output, only the United States and Canada are in a position to cut oil output in order to stabilize the price of oil.  Meanwhile, demand for oil will remain weak in a number of key export markets, as Europe’s economic slump continues and as the pace of growth in demand in China slackens.  As such, without a major cut in oil output in the coming months, oil prices will continue to fall and it is not out of the question that they will fall by more than 50% from their already-low levels.

Such a fall in oil prices would have a major disruptive impact on the global economy.  On the positive side, lower oil prices act as an economic stimulus for consumers and businesses in countries that import most of their oil supplies.  In turn, this could lead to major increases in investment in higher-growth sectors of the global economy, while helping to lift poorer segments of the world out of poverty.  On the other hand, the most negatively impacted countries by such a continued fall in oil prices are those that are dependent upon higher oil prices for much of their economic growth, most notably Russia, Iran and Venezuela.  Moreover, not all areas of the world are welcoming the lower costs of oil as it is driving down inflation rates to dangerous levels.  Already, the Eurozone has fallen into deflation as a result, in part, of these lower oil prices.  While predicting the future direction of oil prices is a tricky endeavor, what is certain is that changes in oil prices will play a very important role in the performance of the global economy in 2015.