Q&A: Seven Questions on Rethinking the Oil Market in the Aftermath of the 2014-16 Price Slump

• Author: Rabah Arezki
• Pages: 10-13

September 2016

9

Oil prices have decrea sed by about 65

percent since their recent peak in June

2014 (see chart). This dramatic and

largely unexpected co llapse in prices ha s

sparked intense debate over th e causes

and consequences. Arg uably, the dynamic

adjustment has change d the oil market structurally, leaving

it quite different from the pas t. In addition, the manner

in which falling oil prices af fect the global economy ha s

changed in important ways.

A broader energy pe rspective is therefore now nee ded to

comprehend oil’s long-term outlo ok. To this end, this article

brief ly answers seven question s about the oil market in the

global economy.

0

20

40

60

80

100

120

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Crude Oil Price (APSP)

U.S. dollars a barrel

Source: IMF, Primary Commodity Price System.

Note: APSP = average petroleum spot price—average of U.K. Brent, Dubai,

and West Texas Intermediate, equallyweighted.

Question 1. Is the Slump Attributable to a “Supply Glut”

or to “Peak Demand”?

The evidence suggests t hat supply factors better explain the

initial coll apse in oil prices in 2014 than do demand fac tors.

A host of issues are involved, including t he rapid increase in

shale production in the United States; a cha nge in strategy

in Saudi Arabia, the la rgest member of the Organization of

the Petroleum Export ing Countries (OPEC); higher-than-

expected output in countr ies such as Libya and Iraq despite

ongoing conflict s; the return of Iranian oil to internat ional

markets; and the United States’ remova l of the oil export

ban (Arezki and Bla nchard 2014). These factors have

persisted. The dyna mic adjustment of investment in the oil

sector to lower prices will conti nue to shape the speed and

extent of any market recovery (IMF 2 015).

Demand factors have also played an i mportant role

(Baumeister and Hamilton 2015). Yet oil demand has grown

unabated since 2011, when growth in emerging marke ts

first slowed. Of course, c hanges in expectations about future

oil demand may also expla in this delayed market response.

Specifical ly, the realizat ion has been gradual t hat the

slowdown in emerging markets is st ructural, not cyclical. In

addition, several episodes of ma rket fright, when oil prices

further col lapsed before rebounding—at the end of August

2015 and January to Februar y 2016—suggest that fina ncial

factors are also releva nt (see Arezki and Matsumoto 2015a).

Question 2. Does OPEC (still) matter?

In theory, the effect iveness of a cartel and its c ompact

depend on the strength of dema nd and supply outside the

cartel. In t he 2000s, strong demand and a relatively strong

OPEC enticed investment and production in high-cos t

areas (such as oil sands in Ca nada and ultra-deep-water oil

off Brazil). Considering t he delay between investment and

production for (conventional) oil, production in non-OPEC

countries peaked ab out the same time as emerg ing market

economies began slowing and ex pectations for future

demand began falteri ng.

In response, OPEC-dominant and lowest-cost producers

changed strategies. I n the past, Saudi Arabia would stabilize

prices by cutting production when price s fell too much

and raising it when they ros e too high relative to a stated

priceta rget.

In 1986, Saudi Arabia attempted to cut production by an

unprecedented margin to support price s even as non-

OPEC production rose rapidly, and the cut failed in

its goals. Perhaps learning f rom the episode, this time

around the country i nstead announced it would step up

production, effectively crowding out hig h-cost producers.

Observers expect t he change in strategy to last to allow

time for it tosucceed.

Seven Questions on Rethinking the Oil Market

intheAftermath of the 2014–16 Price Slump

Rabah Arezki

Q&A