Why have oil prices collapsed?
The interaction between oil prices, supply and demand is notoriously eccentric. None of the three can be relied upon to respond smoothly to changes in the other two. Demand is inelastic: price rises make little difference to motorists’ habit of using their cars. Supply is inelastic: long lead times and giant investment costs mean both that new supply can be slow in arriving, and the shutoff of uneconomic supply can be slow.
Meanwhile, prices respond not to reality, but to perceptions of reality: they rise because there might be a shortage of oil, not because there actually is one. And they fall only when perceptions change.
Arguably, the drop in benchmark Brent crude prices from a peak of some $114/bbl in July this year to below $70/bbl today was well overdue.
Oil demand in the western world and Japan has been stagnant or falling since the financial crisis of 2009 kicked in. Not only is economic growth flat, but technological advancement and the switch to alternative fuels are steadily eroding oil demand - in particular the demand for automotive fuel in the West.
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