Investigating Oil Prices

Oil prices have risen gradually in recent months but are still low and substantially below levels of a couple of years ago. Here, you will see a chart that you won't see anywhere else. It highlights why it is vitally important to understand the reason why oil prices have been low.

If oil prices are low because demand is weak then that is bad news for the world economy. In contrast, if it is ample supply, rather than weak demand, that explains low prices then this should be good news. The graph here helps explain. Along the horizontal axis is demand for oil. Along the vertical axis is the price of oil. There are four quadrants: A, B, C and D.

In quadrant A, demand is rising but oil prices are falling. Here A stands for Ample. There is plenty of oil to satisfy demand and keep prices low. 

Quadrant B, in the top right, is where both demand and prices are rising. B stands for Bright, not only because the lights will remain on but it also shows the world economy is growing.

The top left, quadrant C, is Challenging for the world economy, as demand is falling but oil prices are rising. 

Then, in the bottom left, is quadrant D. D stands for Depression, where demand for oil is falling and prices are falling too. This is a terrible place to be.

Where are we now, and how can we tell? If we look at the last two years oil prices are much lower than they were. This suggests we are in either quadrant A for Ample or D for Depression. These are very different.

So let's look at the data. The best source for energy data is the International Energy Agency (IEA). 

Oil demand continues to rise. In 2012, demand was 90.7 million barrels per day (mb/d). It has risen relatively steadily since, averaging 94.7 mb/d in 2015. In its latest assessment the IEA this month expects demand for the whole of 2916 to be up "a solid" 1.2 mb/d, reaching 95.9 mb/d. Indeed, in the first quarter of this year it was 94.8 mb/d, with higher demand versus a year earlier in India, China and even Russia.

Supply has continued to rise over the same time period. In 2012 supply of 90.9 mb/d just exceeded demand. There has been a sizeable supply gap ever since, and in the first quarter of this year supply was 96.4 mb/d. OPEC has not reduced its output, as Saudi Arabia continues to keep pumping. The latest significant supply change this year, apart from fires in Canada impacting production there, was Iran seeing output reach 3.6 mb/d in April, a level last seen in November 2011. It upped its exports from 1.4 mb/d in March to 2 mb/d in April.

The world economy is sensitive to oil price movements. Losers also react quicker than winners. Energy companies have reacted to low prices by cutting investment plans. Oil producing economies face greater austerity. Also, low prices should help consumers in economies such as the US and UK. Moreover, this has contributed to the benign inflation environment, making it easier for central banks to keep interest rates low.

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