- Oil producers can’t really produce oil for $30 per barrel
A few countries can get oil out of the ground for $30 per barrel. Figure 1 gives an approximation to technical extraction costs for various countries. Even on this basis, there aren’t many countries extracting oil for under $30 per barrel–only Saudi Arabia, Iran, and Iraq. We wouldn’t have much crude oil if only these countries produced oil.
2. Oil producers really need prices that are higher than the technical extraction costs shown in Figure 1, making the situation even worse.
Oil can only be extracted within a broader system. Companies need to pay taxes. These can be very high. Including these costs has historically brought total costs for many OPEC countries to over $100 per barrel.
Independent oil companies in non-OPEC countries also have costs other than technical extraction costs, including taxes and dividends to stockholders. Also, if companies are to avoid borrowing a huge amount of money, they need to have higher prices than simply the technical extraction costs. If they need to borrow, interest costs need to be considered as well.
3. When oil prices drop very low, producers generally don’t stop producing.
There are built-in delays in the oil production system. It takes several years to put a new oil extraction project in place. If companies have been working on a project, they generally won’t stop just because prices happen to be low. One reason for continuing on a project is the existence of debt that must be repaid with interest, whether or not the project continues.
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One of the biggest economic surprises of 2015 is that the stunning drop in global oil prices did not deliver a bigger boost to global growth. Despite the collapse in prices, from over $115 a barrel in June 2014 to $45 at the end of November 2015, most macroeconomic models suggest that the impact on global growth has been less than expected – perhaps 0.5% of global GDP.
The good news is that this welcome but modest effect on growth probably will not die out in 2016. The bad news is that low prices will place even greater strains on the main oil-exporting countries.
The recent decline in oil prices is on par with the supply-driven drop in 1985-1986, when Opec members (read: Saudi Arabia) decided to reverse supply cuts to regain market share. It is also comparable to the demand-driven collapse in 2008-2009, following the global financial crisis. To the extent that demand factors drive an oil-price drop, one would not expect a major positive impact; the oil price is more of an automatic stabilizer than an exogenous force driving the global economy. Supply shocks, on the other hand, ought to have a significant positive impact.
Although parsing the 2014-2015 oil-price shock is not as straightforward as in the two previous episodes, the driving forces seem to be roughly evenly split between demand and supply factors. Certainly, a slowing China that is rebalancing toward domestic consumption has put a damper on all global commodity prices, with metal indices also falling sharply in 2015.
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