January 6, 2015
Lower Oil Prices 2015
Oil prices, long recognized as volatile, have declined
sharply since June 2014. During the last week of June 2014,
the prices of Brent, the world reference crude oil, and West
Texas Intermediate (WTI), the U.S. reference crude oil,
were $113.74 and $107.04 per barrel, respectively, at their
peaks. As 2015 began, the price of Brent was $57.86 and
the price of WTI was $53.46. These prices represent almost
a 50% reduction. It is uncertain how far prices will decline,
or how long the period of lower prices will persist.
During its history, opinions on the degree to which OPEC
can control the price of oil has varied. The method OPEC
can use to control price is to raise oil output if the price is
increasing too much, or to cut oil output if the price is
falling too much. If OPEC pursues these adjustment
strategies, their market share, or sales volumes, increase
during rising prices and fall during periods of declining
prices. In the current environment, it might have been
expected that OPEC would act to support prices.
Since oil is a major traded commodity, used by consumers
and industry the world over, the effects of these sharp cuts
in price are likely to be felt in virtually every nation in the
world. However, whether the effects are positive, negative,
or mixed depends on the economic characteristics of the
particular country. In general, consuming nations, net
importers of crude oil, might be expected to benefit, while
producing nations, net exporters, might be expected to
suffer; many nations will experience mixed effects.
OPEC met on November 27, 2014, and chose not to take
any action to prevent further cuts in the price of oil. Their
decision was to keep their oil output steady, even in the face
of declining oil demand. This action signaled to the market
that they were willing to see their overall oil revenues fall.
Of course, not all OPEC members agreed with this strategy.
While Saudi Arabia, Kuwait, and the United Arab Emirates
supported the strategy, nations that depend heavily on oil
revenues to support their national budgets, like Iran,
Venezuela, and Nigeria objected. Since the OPEC meeting,
informal comments by Saudi officials suggest that the
steady output levels are likely to remain in effect for a
Why Lower Prices? Three key factors have contributed to
the low oil price environment: demand growth, supply
growth, and the actions of the Organization of the
Petroleum Exporting Countries (OPEC).
Oil demand growth largely depends on the growth rate of
the world economy. In 2014, growth in Europe approached
recession levels, Japan was largely stagnant, and even
China saw growth rates fall to roughly one half of what
they were during earlier periods. In the United States,
economic growth was modest in the first half of 2014,
picking up only in the last quarter of the year. The net effect
of this economic growth picture was that oil demand
growth was very weak. Major international agencies
tracking the oil market, including the International Energy
Agency, the Energy Information Administration, and even
OPEC, revised forecasts of oil demand growth downward
On the supply side, output expansion was the key factor.
U.S. supply of light, sweet, shale oil from the Bakken
formation in North Dakota, and the Eagle Ford formation in
Texas transformed the market. U.S. crude oil production
has risen from about 5 million barrels per day (mb/d) in
2008 to almost 9 mb/d in December 2014. This increased
production has reduced U.S. imports of crude oil, causing
exporting nations to look for other markets. At the same
time, weak global demand was reducing selling
While both the demand and supply sides of the global oil
market seemed to be signaling lower prices, one other
critical factor was important, the decisions of OPEC.
OPEC faced a dilemma at the November meeting. If they
successfully supported the price of oil by cutting output,
high prices would have provided a continuing incentive for
U.S. shale oil producers and other non-OPEC producers to
continue to expand output. If output continued to expand,
additional OPEC output cuts would likely have been
required in the near term to keep prices high. Since most of
the burden of reduced output falls on Saudi Arabia, their
financial position might have been compromised, while the
other OPEC nations were shielded from the worst effects.
If OPEC decided, as they did, to hold oil output steady and
let prices fall, all the member nations would share the pain
of reduced oil revenues. Some OPEC nations might even be
encouraged to try to expand their output to preserve
revenues. However, if, as OPEC believed, U.S. shale oil
production and Canadian oil sands production is possible
only in a high oil price environment, then low oil prices
might reduce the growth rate, or perhaps even the level, of
these non-OPEC supplies and create market conditions
conducive to a higher price of oil in the long term.
Who Gains, Who Loses? Because of oil’s importance in
the world economy all major consuming and producing
nations will experience a mixture of positive and negative
effects. For the United States, the benefits of lower prices
are likely to be wide-spread, while the costs are likely to
center on the oil industry and industries and regions that
depend on the oil industry.
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Lower Oil Prices 2015
Since the price of oil directly determines the price of
gasoline, diesel fuel, jet fuel, home heating oil, and a
variety of other petroleum products, individual consumers
and industries that use these products will benefit. Gasoline
prices have declined by over 68 cents per gallon from
December 2013 to December 2014. It has been reported
that these cuts in the price of gasoline translate into about
$630 million per day in savings for consumers. Consumers
can use those savings to purchase other goods and services.
Similarly, the airline and long-distance trucking industries
are reaping substantial cost savings that encourage
in Syria and Iraq through the sale of limited amounts of
captured oil. Any given quantity of oil will yield them less
revenue in the new market environment.
Even though U.S. oil production has increased, the nation is
still a net importer. As a result, the fall in oil prices will
help reduce the nation’s balance of trade deficit, likely
resulting in a stronger value of the dollar.
Issues for Consideration. Two issues that have been
discussed during 2014 may be affected by low oil prices.
As U.S. production of shale oil has increased, there has
been some difficulty in absorbing it into domestic markets.
U.S. refiners invested heavily in modifying their facilities to
accommodate expected supplies of heavy, sour, oil. This
forecast was actually the opposite of what occurred in the
market, a surge in light, sweet, oil. As a result of the
refinery mismatch, Bakken and, to a lesser extent, Eagle
Ford shale oil has sold at a price discount compared to
WTI. Producers, hopeful of enhancing their revenues,
began to petition for lifting the ban on U.S. oil exports
which has been in place since 1975.
Other consuming nations, including those in Europe and
Asia will also experience consumer benefits. However, the
lower price of petroleum products coupled with stronger
economic growth may increase the demand for these
If all oil prices decline proportionally, pressure to allow the
general export of U.S. crude, now possible only to Canada
and through several other minor exceptions, will continue.
If the low oil prices reduce the Bakken price discount, the
debate on oil exports will likely be affected.
The low price of oil is difficult for firms in the oil industry,
weakening their financial position and inducing them to
curtail investment plans. The key asset held by oil industry
firms are their oil reserves. As those reserves decline in
value, the balance sheet of the firm weakens and their share
prices tend to decline. In addition, the lower price of oil
also reduces cash flow, and potentially profitability, further
weakening the share price. The overall effect of low oil
prices on the stock market is uncertain however, because
while share prices of oil industry firms are declining, the
prices of oil consuming firms, like airlines, are rising.
Virtually all oil sector firms are hurt by low prices, but
perhaps those small firms involved in shale production,
depending on cash flow and debt financing, suffer the most.
The second issue affected by low oil prices may be the
federal gasoline tax. The gasoline tax, used for highway
maintenance and construction, has not been changed since
1993. Since that time, maintenance and construction costs
have risen. The Highway Trust Fund has become
chronically short of funds. With the rate fixed at 18.3 cents
per gallon, revenue only increases as more gallons are used.
Recently, however, due to increased fuel efficiency and
fewer miles travelled, gasoline usage has declined or is
stable, reducing revenue potential. Conversely, low
gasoline prices may motivate higher consumption, and
If the firms largely responsible for the increase in shale oil
production falter, and either reduce exploration and
development investments, or actually reduce output, U.S.
production growth might slow and provide a market
correction for low oil prices. Of course, a reduction in oil
extraction rates in 2014 leaves more oil in the ground for
the future, perhaps extending the time horizon for shale oil.
State and local revenues from oil-related taxes, royalties,
and lease payments may decline with the price of oil.
Some nations are likely to experience largely negative
effects due to lower oil prices. For example, Iran, Russia,
and Venezuela, nations that depend on oil to drive their
economies, are in trouble. On December 16, 2014, Russia
was forced to raise domestic interest rates from 10.5% to
17% to attempt to protect the value of the ruble which had
been declining along with the price of oil. Iran, faced with
low oil prices in addition to economic sanctions, is finding
it difficult to finance the government. It was reported that
Venezuela is being squeezed out of capital markets, and
may become ungovernable. A quasi-state damaged by low
oil prices is ISIS. ISIS has been financing military activities
Due to taxpayer resistance, it is difficult to increase
gasoline taxes when prices are high and rising. It may be
possible to increase the tax in an environment of low and
declining prices. Consumers may be more willing to
sacrifice a portion of a price decline in the interests of
improved highway maintenance and construction.
The Future. While the near-term market conditions suggest
continuing low oil prices, a sharp cut in output by Saudi
Arabia could change the market quickly, albeit at
substantial cost to the Saudis. In the longer term, the
inability to predict oil prices almost guarantees that analysts
will be surprised by the evolution of the market.
Robert Pirog, email@example.com, 7-6847
www.crs.gov | 7-5700