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As a Penn State professor who often commutes to State College from Washington, D.C., by car, I’ve recently felt some weight return to my wallet. Hooray – gas prices finally have dropped! But, unlike some Americans, I’m not rushing to buy trucks and SUVs.
To no surprise, Americans took advantage of low gas prices. Over the last four months, SUVs and light trucks made up 54 to 55 percent of the new car market, up from 51 percent in the first four months of 2014.
Yet, Americans might be a bit too hasty. While oil prices might not climb to prior lofty levels, the market will return.
Rewinding back to last June, oil prices plummeted in response to increased global production, to which the United States made immense contributions by nearly doubling domestic production in the last six years. This increased production put substantial pressure on oil prices at a time when global consumption decreased due to slowed growth in Europe and Japan. Other factors, such as exporters’ competition in the Asian market and rising production levels in Russia and Canada, also contributed to the drop.
As the world’s largest exporter, Saudi Arabia can influence oil prices. Notably, the country decided to continue its production levels amid decreasing prices and profits. As predicted by The International Monetary Fund, the revenues of Saudi Arabia and its Persian Gulf partners will drop by $300 billion this year. But because of its substantial cash reserves and low production costs, Saudi Arabia is willing to take the hit to preserve its long-term dominant position in the market.
Yet other countries, such as the United States, won’t be as easily able to continue the historical expansion of their production. Even with the newly developed, efficient horizontal fracking, U.S. shale costs $40 to $70 a barrel to produce.
Because costs are even greater to start a new field, oil prices will discourage U.S. exploration and production companies from drilling new wells. This scenario is already happening. The number of rigs drilling for oil in the United States dropped to 1,019 from 1,425 a year ago.
Typically, shale oil wells are most productive in the first two or three years of their productive life. They also dissipate more quickly than traditional oil fields in Saudi Arabia, which last for 15 to 20 years. This reinforces Saudi Arabia’s market share position.
Iran, Venezuela and Russia also will have difficulty sustaining prior production rates. Oil companies might fall into debt, go out of business or have to seek out bank loans in order to continue operations. Therefore, the global supply will decrease.
But as the economies in Europe and Japan recover in 2015, demand will begin to increase. If the global demand gradually rises as expected, alongside a production slowdown in the U.S. and other producing countries, prices will increase. While they might not rebound to $100 (as it is unlikely prices will climb much higher than the cost of production in the U.S.), countries will be able to continue production. The timeline for this market return is challenging to predict because it largely depends on the large consumer nations’ pace of recovery.
While low prices might have pleased consumers’ New Year’s budget resolutions, it’s imperative to remember this isn’t a permanent shift. The little hybrid that previously called your name might be the right decision after all.