The Great Recession of 2007 to 2009 saw the Brent oil price reach an all-time high–147.50 USD–before a rapid decline to 53 USD. The following economic recovery led to oil prices increasing up to 125 USD in 2012, and then fluctuating within the 100 USD to 125 USD range from 2012 to 2014. Despite this recovery, oil prices started falling drastically from 2014 to 2016, bottoming out at 44 USD. In this article, we will explore the various reasons behind this drastic plummet in oil price as well as OPEC’s role in this crisis.
Firstly, we will explore the supply side contributions to the global oil industry that lead to the oil price crisis. The United States’ shale oil production increased from 0.4 million barrels a day to more than 4 million barrels a day from 2007 to 2014. This was a result of the high price of crude oil, rendering new drilling technologies to become cost competitive. These high oil prices also incentivized Canada, the country with the third largest oil reserves, to increase production. By utilizing fracking in the oil sands of Alberta, Canada was also able to flood the global oil market, putting downwards pressure on oil prices.
Saudi Arabia also played a large role in the oil crisis. During the falling prices, Saudi Arabia had two options: either to continue letting oil prices drop by maintaining production levels or reducing production levels in order to increase prices while losing market share. Since Saudi Arabia holds the largest oil reserves in the world, the country decided that it would be more profitable to maintain production levels rather than giving up market share. The country’s large oil reserves along with its capability to produce oil cheaply allowed it to sustain low oil prices for extended time periods, all without much detrimental impact to its economy. By maintaining its current oil production levels, Saudi Arabia also hoped that the lower oil prices would force out other competitors like the United States and Canada, since both North American countries use more expensive methods of extraction such as fracking.
Secondly, we need to explore China’s role in the global oil market in terms of the demand side contributions to the oil crisis. China has the world’s largest population and, as a country, saw massive growth and rapid expansion of its economy in the first decade of the 21st century. Among other large countries facing similar economic growth, the demand for oil skyrocketed \ which led to the high global oil prices as seen in 2008. However, this period of rapid economic growth eventually slowed down after 2010., leading to a decrease in these countries’ consumption of oil thus leading to a significant drop in the global oil price. Furthermore, the decrease in demand for oil from China further deteriorated oil prices. As such, the countries that pushed oil prices to record high levels were also the ones responsible for its price drops in 2014.
Lastly, we explore the role of the US dollar in the oil crisis. The strengthening of the US dollar is one of the contributing factors for the decreasing oil price in 2014. Since commodities are normally traded in US dollars, there is a direct relationship between oil prices and the US dollar. In the early 21st century, the US Federal Reserve (Fed) reduced interest rates to decrease the impact of the 9/11 attacks and the dotcom bubble. In doing so, the US Fed limited the damage to the stock market by reducing the value of the US dollar. This also led to an increase in the prices of commodities since most of them are priced in US dollars. During the 2008 financial crisis, the US Fed dropped interest rates to zero percent and engaged in quantitative easing in order to reduce the value of the US dollar. By doing so, markets were restored but commodity prices began to increase. In 2013, the Fed began strengthening the US dollar by reducing the pace of quantitative easing and increasing treasury yields. This finally led to decreasing commodity prices and consequently, decreasing oil prices as seen in 2014.
The increasing oil prices from an unsustainable source of demand led to an increase in oil production to satisfy such growing demand. Eventually, as demand collapsed, prices regressed. Due to the inelastic nature of oil, this price drop had little positive effect on demand. Economic crises showed how Fed intervention influence oil prices and the importance of the value of the US dollar in the global commodity prices. Therefore, we can observe how these various contributing factors led to one of the worst oil crises in recent history.