THE REASONS BEHIND FALLING OIL PRICES

crude oil extraction

We have been experiencing a dramatic drop in oil prices. This is a much welcome relief to a country like Kenya, which is largely an oil consumer that has been struggling with high energy costs for decades. To a large extent, this is favorable to the Kenyan economy. Lower energy prices reduces cost push inflation since production costs by local manufacturers goes down. Ultimately the prices of commodities goes down too. Other winners are the transport sector and airlines like the Kenya Airways whose fuel accounts to nearly 40% of its direct costs.

To fully understand the dynamics behind the plummeting oil prices, it's important to look beyond the Kenyan scene - the global oil market. Global markets have been transfixed by an oil price free fall. In 2014, the prices of crude oil surged to a high of about $115 per barrel. Crude oil prices have since been plummeting dramatically to a low of $49 per barrel on 23rd Jan, 2015.

Crude oil prices have been hovering around $100 per barrel since 2010. This is because of the soaring oil consumption globally especially in much active economies like China. This huge demand has kept oil prices high.

In addition key oil regions have been facing geopolitical conflicts. For instance the civil war in Libya, ISIS threats in Iraq, and the US and EU slapping sanctions on Iran has pinched oil exports. Collectively, this has taken about 3 million barrels a day of crude oil from the global oil market. These issues have constrained oil supply in the global market which has contributed in maintaining the oil prices up.

However, since mid 2014, these outages and conflicts are not so much significant. The dynamics have now shifted and the supply has been growing and has outdone the demand.

Oil prices have been falling for two main reasons.

• The supply has exceeded the demand.

The persistent high oil prices spurred companies in the US and Canada to start drilling for new hard to extract crude in North Dakota's shale formation and Alberta's oil sands. America started producing oil since 2008 and has since become the the largest oil producer. Though it does not export oil, it has since been importing much less. This has led to a boom in "unconventional" oil production (oil production by non-OPEC countries). Also, the demand is low because of weak economic activity, increased efficiency and a growing switch away from oil to other energy sources.

• In its big meeting, OPEC did nothing.

OPEC members met in Vienna on 27th Nov, 2014. Observers were watching whether the biggest oil cartel (OPEC states) would agree to cut on their production. Saudi Arabia didn't want to give up its market share, so it refused to cut on its production. It hoped that the lower prices would throttle the US shale boom. OPEC maintained that production by members would continue as usual at 30 million barrels per day. So the prices went on a free fall.

Low oil prices are excellent news for consumers like Kenya, Japan, China etc.

However, pressure is mounting on oil producers, especially oil reliant economies. Russia's economy is now facing a potential meltdown. Venezuela is facing unrest and may default on its debts.