Image: LINN Energy.
Oil prices plunged this week as a number of factors converged to push energy lower and the pressure may continue for sometime. The news could be a nice reprieve for drivers who are in the middle of the summer driving season, but it comes at a bad time for a stabilizing U.S. oil industry.
To understand why oil moved so sharply this week and what to expect going forward let's look at where oil markets stand today.
Iranian nuclear talks are progressing
One of the factors that has kept oil prices high for more than a decade has been constant conflict in the Middle East. War in Iraq, the Arab Spring in Libya and Syria, even sanctions on Iran have helped keep supply of oil subdued and kept prices high. Today, we're in a time of relative peace (excluding ISIS) and there's little disruption in oil production expected near term.
That's why this week's news that nuclear discussions with Iran, which could lead the country's oil to hit the global oil market once again, have created downward pressure on oil. If Iranian sanctions are lifted and foreign investment is opened up there could be a huge impact on oil supply. Iran produced 2.8 million barrels/day of oil last year but production has been high as 6 million barrels/day, so Iran's economy opening to foreign investment would be a big deal.
With the fourth largest reserves of oil and the second largest reserves of natural gas in the world, the country has the capability to increase oil supply enough to keep prices lower for many years to come.
Greece's default helps the dollar
Another factor that pushed oil lower this week was Greece. No, Greece isn't a big exporter of oil but it does have a big impact on currency markets. When Greece defaulted on a $1.7 billion payment to the IMF it pushed the Euro lower and by extension the dollar higher. In global markets, a more valuable dollar means a dollar buys more oil, pushing oil prices lower.
Euro to US Dollar Exchange Rate data by YCharts
I highlighted how important currency is to oil markets a couple of months ago and this is just another example of how it can affect oil prices, even on a weekly basis.
Inventory is rising
Another long-term challenge that oil has been fighting is rising inventories in the U.S. Inventory rose sharply in early 2015 only to slide slowly over the past couple of months. Last week inventories rose and that was at least a little unnerving for oil bulls.
Source: Data from U.S. Energy Information Administration. Chart by author.
Inventory alone wouldn't push oil prices lower in the dramatic fashion we saw this week, but combined with progressing talks with Iran and a rising dollar there were plenty of reason for oil to fall this week.
Will the oil plunge last?
Oil has been stable at around $60 per barrel since early May, but the events of this week could send it lower for a sustained period. Iran, in particular, could have a very long-term effect on the oil market if it increases supply in any meaningful way. That could offset the reduction in production U.S. shale drillers and Canadian oil sands producers are going to see in the next year or two.
Depending on how you look at it, a long decline in oil could be great news or a terrible trend. If you're an oil investor it's something you don't want to see, but if you're just looking forward to lower cost gasoline, it's a good thing. The perspective is in the eye of the beholder.
