Oversupply driving low oil prices, not weak demand

It was back in October of 1973 when I was still in high school that the world encountered its first major oil crisis when the members of the Organization of Arab Petroleum Exporting Countries (OPEC) proclaimed an oil embargo. By the end of the embargo in March 1974 oil prices had risen from $3 per barrel to nearly $12 globally with prices in the United States were even higher. To those of us impacted by this change, it was natural to assume there was a shortage of oil. I can remember thinking that we would be lucky to have any oil left by the mid-1980’s but at the time I knew little of economics and the principles of supply and demand.

Since then we have gone through a number of price spikes and crashes, either created by supply or demand challenges. The most recent, in 2009, was driven by weak demand after the crash in a number of important economies. Today’s low oil prices, however, are driven by oversupply, not weak demand. Saudi Arabia appears to finally gotten weary of cutting its own production while other members of OPEC and non-members continued to pump out as much oil as they could. OPEC continues to pump out its full quote of 30,000,000 barrels per day or even more to drive the price down. While many readers are aware that the Saudis are trying to punish the higher cost producers, such as shale oil in the United States or the oilsands in Canada, there is a second element to this strategy, which is to increase demand through lower prices. For now they seem content to let the market determine oil prices rather than manipulate supply.

While many suspect this OPEC strategy as being purely political, it is more of a market-driven decision. Whether it will bring any positive benefits to the Saudis is debatable at this point. They are running $100 billion deficits but with $600 billion in savings, they can afford to wait awhile. Some accuse the Saudis of attempting to weaken their neighbors, especially Iran, and there is probably some truth to that with the two of them waging a proxy war in Yemen and being involved in competing interests elsewhere.

The current oversupply means oil prices are on a slow recovery, but how long will it take? We will explore this topic further in a future post.

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By Malcolm Roach, President and CEO of Open Door Technology