Prices at the pump have been falling since late last year – a trend that has consumers smiling and gas producers nervous. What’s behind the drop in gas prices and how long will prices stay low?
Gasoline is refined from oil so when we talk about gas prices we are really talking about the price of oil. There are three main factors behind oil prices: supply, demand and market expectation.
Supply and Demand
Oil is used for more than just gas. It is one of the primary sources of energy for electricity, heating, manufacturing, farming and more. In a good economy demand will be higher. In winter, colder countries (like Canada) need more energy for heating while warmer countries use more energy to run air conditioners in the summer. Supply can be affected by environmental factors but for the most part supply is determined by the Organisation of Petroleum Exporting Countries (OPEC). Saudi Arabia has the largest portion of OPEC’s oil production.
Oil is a commodity and can be traded like a stock. This means investors can also impact the price of oil. When prices begin to drop, or the market outlook is negative, investors can be scared out of the market and so will magnify price movements. So when the price of oil begins to drop investors start pulling out and the price drops even further. When the price of oil starts to rise investors start buying again and makes the the price go up quicker.
So why is Oil cheaper now?
In order to explain why the price of oil has been dropping we have to look at the three factors listed above: supply, demand and market expectations.
Over the last decade Canada and the United States have both increased oil production. America has become one of the worlds largest oil producers and even though it doesn’t export any of its oil it doesn’t need to import as much either. This means that there is a surplus of global oil supply and prices should drop. Except: Usually when there is an oil surplus OPEC agrees to cut oil production in order to keep prices high.
So an oversupply usually doesn’t lead to a break at the pump. This time however OPEC hasn’t cut supply and neither have the US or Canada – supply is still high so prices are low.
Demand is Down
Demand for oil is not as high as it has been in the past because of global economic problems and greener technology. Since the housing crisis in 2007 the world economy has been fragile. Canada and the US have recovered faster than Europe and China’s massive expansion has finally showed signs of slowing.
Concerns over climate change and the previously high cost of energy have reduced our reliance on oil. Alternative energy sources have become more popular and cars, homes and businesses have become more energy efficient than ever.
Market Expectations are Uncertain
When the price of oil starts to fall – due to either oversupply or less demand – some investors might be scared out of the market. This causes the price of oil to fall further. But long term predictions can also affect the price of oil. If investors think the price of oil will rise over the medium to long term then they will continue to invest. This leads to the question:
How long will cheap oil last?
Well, Martin King – a seasoned oil price forecaster – says the price of oil could average out to as low as $54.50 a barrel this year. Others say that the price could rebound or even skyrocket over the next few years. But don’t start stockpiling cheap gas in your basement just yet… or ever…that sounds like a terrible idea.
It is almost impossible to know how long cheap oil will last. For now it seems like consumers will continue to save at the pump. However the long term effects of cheap oil are still unclear. Domestic oil producers could be seriously damaged and countries reliant on oil exports could face economic challenges.
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