Why Fluctuating Oil Prices Are Here To Stay
Three years ago, in an essay for Foreign Affairs, we predicted a new era of volatile oil prices. The market laughed at us: the next three years were the smoothest in decades. Oil prices, on average, moved just three percent each month and even less from year to year. The calm was so eerie that analysts began to hail a new era of oil price stability.
The past month, however, has upended that confident view. What began as a gradual slide, from $115 a barrel on June 19 to $100 a barrel by September 8, turned into something more serious, with prices plunging as low as $84 by mid-October. Volatility is back—and our 2011 essay explains why.
The story began this summer, when oil prices began to fall due to weak economic growth worldwide and increased oil production in Libya. More supply and less demand normally lead to lower prices, but traders assumed that Saudi Arabia—the largest oil producer in OPEC—would curb its own production to keep the market stable, creating a price floor of about $90 per barrel. Instead, Saudi Arabia shocked the market, hinting that it could live with lower prices and would not rush to cut production. As a result, prices dropped precipitously.
If they had been reading Foreign Affairs, traders might not have been so surprised. In our essay, we argued that Saudi Arabia and its partners in OPEC were no longer able or willing to hold and use spare production capacity to stabilize the market as aggressively as before. In the past, as we wrote, if demand rose unexpectedly or if supplies were disrupted, OPEC producers with spare capacity, most prominently Saudi Arabia, would release more oil, balancing supply and demand and keeping prices stable. During the 2000s, however, Saudi spare capacity slowly dwindled, shrinking Riyadh’s ability to prevent price swings. The Arab Spring didn’t help: With demands for domestic spending on the rise, cutting production and sales became even more difficult for a country dependent on oilRead the full article on ForeignAffairs.com