Oil Prices: Why Crude Fell More Than 9% in a Week

Oil Prices DropAs the United States and Iran approach a deal, crude oil dropped by over nine percent on expectations of weaker prices. If sanctions on Iran are lifted and the country reintegrates into the international community, it could add 2.3 million barrels of oil to the global supply. (Source: The Wall Street Journal, July 5, 2015.)

Oil prices have fallen nearly 45% in the last 12 months. Analysts are concerned that Iran’s additional production would put downward pressure on the commodity, even as demand remains weak.

The deal is being negotiated between Iran, the U.S., France, Russia, China, the U.K., and Germany. The original deadline has been extended twice and currently sits at Thursday July 9th. (Source: The Wall Street Journal, July 7, 2015.)

Price and Supply

As a commodity, the price of oil is heavily swayed by demand and supply. During the mid-2000s, global demand for oil outstripped supply. By 2011, prices reached $100.00 per barrel.

An outbreak of political unrest swept the Middle East in 2011, keeping oil prices above $100.00. The deteriorating situations in Libya and Iraq, combined with Iranian sanctions, sapped the daily flow of oil by another three million barrels. (Source: Energy Information Administration, July 7, 2015.)

The higher prices allowed companies to start extracting oil from places that used to be economically unfeasible. One of the chief beneficiaries of the oil boom was the United States, which experimented with new techniques like fracking and horizontal drilling. (Source: Vox, November 28, 2014.)

Starting in 2008, the “tight” oil boom in the United States quietly added four million barrels to the market. When Libyan oil production ramped back up and demand from East Asia slowed, markets finally adjusted to on-the-ground realities.

Supply now outstripped demand.

Iran vs. Saudi Arabia

Saudi Arabia is continuing to exceed output projections despite the oversupply issue. They have publicly stated an intention to maintain their current market share, despite the growth of U.S. firms exploiting shale reserves.

In fact, as oil prices plummeted in 2014, the Organization of Petroleum Exporting Countries (OPEC) met in Vienna to plan the cartel’s response. Iran requested that Saudi Arabia scale back production in order to stabilize prices.

Saudi Arabia refused. Many analysts believe that this move was designed to drive higher cost competitors out of business. Saudi Arabia’s breakeven point on production is lower than Iran’s or the United States’, giving it the freedom to engage in a price war. It is also the largest oil producer in the world, generating a whopping 10.85 million barrels a day.  (Source: Real Clear Energy, October 22, 2012.)

The consensus view is that a deal between Iran and the United States is meant to counter the market power of Saudi Arabia. Regardless of the specifics of the deal, its outcome is sure to roil oil markets in the coming weeks.