Oil Prices and Global Economics

Though some analysts believe that this is a mere blip, the majority opinion is that there are some
fundamental forces at work which should keep the price of oil low in the foreseeable future.
The continuing slow-down of Europe and Japan, and the reduced growth in the big emerging economies
like China, India, Brazil and Indonesia have lowered the growth in demand for oil.
But the more important forces are operating on the supply side in the form of huge discoveries of new
sources of energy like shale oil and gas in countries like the United States and Canada which
horizontal drilling and fracking technology has made possible to extract at a cost in the $85-90 range.
Nearly all of the recent growth in global oil production is coming from the US and Canada and the
former is expected to surpass Russia as the biggest producer of oil in the near future.
(By the way, contrary to popular perception, Saudi Arabia is not the biggest producer of oil, it has the
highest known reserves of oil in the world).
Even renewable energy sources like solar and wind power, though initially much costlier than fossil fuel,
are going through a phase of rapidly falling costs due to economies of scale and improved technologies.
Thus, the Organization of Petroleum Exporting Countries (OPEC) cannot afford to keep price above $90
for an extended period without taking the risk of being competed out by the new energy supplies.
Can this process be reversed? Yes, to some extent if high growth returns to the major economies of the
world lifting the growth in demand for energy.
Also, the supply of shale oil and gas may suffer a setback if the new and in many cases relatively
untested technologies cause any major environmental disaster which would strengthen the ongoing
protest of the environmental lobbies against these technologies.
OPEC members led by Saudi Arabia may also try to reverse the trend of falling price by cutting
production of oil.
But, given that a price of oil above $90 may give a big boost to the alternative energy sources (thereby
undermining OPECs power in the long run), it would need a corresponding huge cut in OPEC
production.
Even if Saudi Arabia may afford to do it for some time, it would be very difficult to enforce that much
production cut on other smaller players who desperately need oil revenue for sustaining their
economies.

Of course, any major disruption in oil supply due to war or natural calamities may cause temporary
spikes around the trend price.