The Oil Conundrum

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The article focuses on the effects that low oil prices have had on the global economy. It highlights some of the negative effects such as a decrease in investment, increased turmoil in financial markets, increased unemployment, and a slowdown in the global economy. Theoretically, lower energy prices are expected to trigger economic growth but the current downturn has given investors and policy makers cause for concern.

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The low oil prices are driven by an oversupply of the commodity to the global market. Iran recently re-entered the oil export industry promising to produce 500, 000 barrels a day. This move, coming at a time when their rivals such as Saudi Arabia and Nigeria are pumping at record levels has increased global crude supply exponentially. The US has also become one of the largest oil producers as technological innovations have improved the ease of extracting oil from shale. The increased production from the US and other producers such as Russia and Venezuela comes at a time when Chinas economy, one of the largest consumers of oil is experiencing a demand slowdown. This has created an oversupply problem as shown by last years statistics where global production was 96.3 million b/d of oil while consumption was only 94.5 million b/d. Therefore, each day saw about 1.8 million go into storage tanks much similar in function to the Oil tankers anchored off the Iranian coast.

Reducing oil production may seem like the obvious solution to the problem but an analysis of the costs involved versus expected benefits reveals the underlying conundrum. Large depreciations on national currencies against the dollar have made countries depending on oil revenues such as Russia and Brazil to maintain oil output to increase local currency reserves relative to the costs of maintaining production. Additionally, after the recent Paris summit raising awareness on environmental concerns, some producers fear that oil prices may never recover as consumers opt for alternative energies. OPEC, an oil cartel, may have overestimated the positive effects of a drop in oil prices. In the past, they have attempted to flood the market with cheap oil in order to drive out less efficient competitors but have failed. A subsequent policy meant to gain market share from their competitors resulted in internal feuds thereby further depreciating oil prices. Yet there remain reasons for continued production that are not as desperate as they seem. The cost of shoring up wells is much higher than the costs associated with continued production once the necessary infrastructure is in place.

The fact that has surprised many is their indirect exposure to the oil industry. Machinery parts manufacturers and repair shops have experienced a reduction in revenue although some do not depend on direct orders from oil producers. Additionally, the oil crisis has revealed the fragility of the global financial system. The end of the Feds program of quantitative easing resulted in an increase in interest rates thus drawing the dollar back to America and tightening global monetary conditions. Countries and corporations especially in emerging economies have had to borrow abroad to finance their operations. The yields on oil based securities are also up as the associated risk increases. The oil industry is at a crux as shale production becomes viable which exposes vast amounts of resources previously thought unrecoverable. The companies have to make some crucial decisions on whether to continue drilling, invest in shale and greener technologies or return profits to shareholders thus signifying the end of the fossil-fuel era.

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