Current and Future Crude Oil Prices

Douglas Stanley

Current and Future Crude Oil Prices

What has been the main driver of the falling oil prices? What are oil prices likely to do in the future?

Introduction[pic 1]

A core principle in the basics of macroeconomics is the supply and demand curve. With quantity supplied on the x-axis and price of the good on the y-axis, the market finds equilibrium at the price and quantity that the supply and demand curves intersect. As illustrated in the picture, an increase in supply shifts the supply curve to the right, causing the new market equilibrium price to decrease. Typically, demanders love the decrease in prices but suppliers generally get their profit margins squeezed during this period.  

Over the last several months, crude oil prices have gone from a high of $102.53 in mid-June to a low of $63.72 in late November (1). What is the cause of this large decrease in price? As illustrated in the picture, we are experiencing a glut of supply that has cut prices substantially over the last few months. The efficient Shale Revolution in the United States, OPEC deciding not to cut their oil production, and a strong U.S. dollar relative to foreign currencies deserves the blame for recent drops in oil prices. In the short-term, we are likely to see oil prices continue to decrease to the $55-$60 range, but will stabilize in the $80 dollar range in about 2-3 years.  

Causes of the Increased Crude Oil Supply

Hydraulic Fracturing leading to the U.S. Shale Revolution

Hydraulic Fracturing, or “fracking,” is a process used to extract natural gas and crude oil out of shale formations ranging from 5,000-8,000 feet below earth’s surface. The fracking process involves pumping water, chemicals, and sand slurry (proppant) at high pressures into a well, fracturing the shale formation. As the shale formation is fractured, it opens up passages for trapped oil and natural gas to escape the shale, which previously could not be accessed (2).

[pic 2]

The birth of what is now known as “fracking” was first originated in the 1930s. By injecting non-explosive fluids into the ground, oilers attempted to break through shale formations to drill wells. Halliburton, an oil field services company, tried to consistently use this method for drilling as early as 1949, but it had little resemblance to the method of fracking we know today. As individuals continually tried to perfect this method, Congress passed the Safe Drinking Water Act in 1974, which prohibited harmful substances from being injected into the ground. This slowed the development of fracking significantly. After fracking was proved of having “little or no threat” to the drinking water, the Energy Policy Act of 2005 exempted it from the Safe Drinking Water Act prohibitions and the energy industry began to boom in the U.S. (3).