The drop in oil prices….explained

The first question my 5th grade history teacher asked me was why we had to study history. My answer was that it helps us seem more intelligent. If we are sitting at a table talking about historic events the person who is engaged in the conversation seems to be intelligent. That was my logic as a 5th grader and I want to apply that same logic with an explanation on the drop in oil prices.

It might not help your specific investment situation, but it sure doesn't hurt being able to answer the question of why prices at gas stations are so low when sitting around a group of friends.

Let's start in the US....

The US has overtaken Saudi Arabia as the world's largest producer of oil. The US is currently going through what most have called a "shale boom". This shale boom was made possible by an extraction method known as hydraulic fracturing, or "fracking". It is a process by which highly pressurized liquid is injected into shale rocks that essentially makes them explode and oil is able to be extracted from these rocks. It is a controversial extraction method as many environmentalists have claimed that the liquid used in the process is polluting surrounding water sources.

The method by which oil is extracted from shale rock is more expensive than the regular drill and pump method that is being used in Saudi Arabia, therefore the break even price per barrel of oil for US frackers is higher than that of Saudi Arabian producers.

Into the Middle East we go....

Saudi Arabia, as a member of OPEC, has the ability to control oil output and therefore manipulate prices. If they wanted to increase the price of oil, they could simply stop pumping oil which will in turn reduce supply which would cause the price to go up.

So why don't they?

Saudi Arabia very well knows that US frackers have a higher break even price than they do, and so they are trying to kill the shale boom in the US by keeping production at max capacity and keeping supply high in order for prices to remain low. Already this is, to some degree, working. There have been a number of frackers who have gone out of business because they were not able to operate at the current price of oil.

Off to Europe:

There has been a slow down in the European economy, and energy demand across Europe has decreased.

The sudden drop in oil prices is not attributable to the theory of coincidence; that all things just came together at once, but one event led to another and now we are enjoying low gas prices.

In a very small nutshell, the decrease in oil prices has been caused by an excess amount of supply and not enough demand.