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Why is Oil Trading Below $40 a Barrel?

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Why is Oil Trading Below $40 a Barrel?

Aug 24 2015, 11.27am GMT


Friday saw oil fall below the important $40 a barrel level as the price for West Texas Intermediate crude dropped to $39.86, in intraday trading. This marked the first time the price has dipped below the important $40 level since March 2009.

Although the price rallied to settle at $40.45 at the close of the trading session, this still meant a decline of 87 cents for the day.

The price of U.S. crude oil has now fallen for 8 consecutive weeks, the longest such stretch since 1986.

Phil Flynn, senior energy analyst with the Price Futures Group said, “it is a very important psychological level. It really signals that the global economy is in trouble.”

There are a number of fundamental reasons why oil prices are at such depressed levels as well as indications that the price might fall still further in the near future.

While the supply and demand ratio is one of the deciding factors governing the oil price, the background reasons that affect these production and consumption levels are the prime underlying reasons for the low oil price.

Statistics from a BP oil review as at the end of 2014 are indicative of the problem facing the world oil market and are very revealing.

The report shows that global oil consumption grew by 0.8% or 800,000 barrels a day, well below the 2013 growth in oil usage of 1.4 million barrel per day. Chinese consumption was well below average, but still increased by 390,000 barrels a day while Japanese oil usage fell by 220,000 barrels daily to its lowest levels since 1971. The International Energy Agency boosted its forecast for oil demand to grow by 1.6 million barrels a day, the fastest rate in 5 years. This forecast has however had no apparent effect in boosting oil prices.

Production of oil on the other hand increased globally by 2.3% or 2.1 barrels a day. The U.S., which increased production by 1.6 million b/d, recorded the largest growth in global production in 2014, becoming the first country in the world to increase production by more than 1 million b/d for 3 successive years while taking over as the world's largest producer from Saudi Arabia. The growth in global production continues to outstrip the growth in consumption.

Meanwhile, the increase in U.S. oil production has been on the back of shale oil fracking, although production from that source is starting to decline as its higher production cost makes this method of oil extraction less economical.

Also, non OPEC production has been slowing during 2015 in response to the low prices while OPEC has continued to increase its production levels with Reuters placing the level at more than 32 million barrels per day. The OPEC tactics are not directly related to price, but more to regaining market share lost to non OPEC members. The double edged sword for OPEC is that if it cuts production and prices go up, U.S. shale oil production once again becomes viable.

The possibility of Iranian crude reappearing on the global market in the aftermath of the international nuclear agreement is another potentially disruptive factor facing the oil world. While Iran says it will be able to ramp up production very rapidly once sanctions are lifted, oil analysts have expressed doubt about the country’s infrastructure capabilities to effect a quick resumption of oil production.

The continuing strength of the U.S. dollar (USD) has also had an impact on all dollar denominated commodities which cost more in local currencies as the dollar strengthens. The prospect of an increase in U.S. interest rates and an even stronger dollar would weaken prices even further. Analysts such as Binky Chadha chief global strategist at Deutsche Bank have presented the argument that the strong and rising dollar is the primary cause behind the weakness in the price of crude.

MT4 Chart: Oil

Oil below $40 per barrel

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