Oil For Dummies: An Explanation Of The Oil Crisis For Anyone And Everyone

by: The Intercollegiate Finance Journal

By Varun Narayan

Oil. It dominates the news, the markets, and an entire section of global politics. Most people, however, know little more than that their tank of gas no longer puts such a large hole in their wallet. But in an era when widespread information plays a critical role in the distribution of power, everyday individuals have an incentive - no, a responsibility - to learn why oil prices have dropped, how it has impacted the global economy, and what might happen should prices rise or fall.

Double, Double, Oil in Trouble

Pricing is generally a matter of supply and demand, and oil pricing is no different.

Over the last few years, the supply of oil has surged upward. As the shale revolution has gripped the United States, both small and large oil exploration and drilling firms have tapped our nation's underground and offshore oil resources - a trend that has driven American oil production skyward.

OPEC member states as a whole have upped their own oil output, and both the Canadians and the Russians, in spite of their myriad economic problems, have been pumping more and more crude oil every day. While some countries have begun freezing their production levels, such reductions cannot compensate for the massive increases coming from deepwater oil drilling.

The Saudi Steamroller

Some analysts point to potential political conspiracies to uncover the cause of the oil price meltdown. Many of these theories center on Saudi Arabia, a key American ally and one of the world's largest oil producers. One mainstream theory maintains that Saudi Arabian production has risen in order to lower the price of oil and, in turn, drive smaller oil-producing nations and American oil firms out of the market, whereby it could preserve and grow its market share in the long run.

Another key theory submits that Saudi Arabia has lowered the price of oil primarily to hurt one pivotal state: Iran, Saudi Arabia's archenemy. Iran, whose government depends heavily on oil revenue, needs oil at $131 per barrel in order to balance its budget, compared to Saudi Arabia at only $104 per barrel.

Simply put, low oil prices hurt Iran more than they hurt Saudi Arabia, and can act as a tool of economic warfare.

Oil-Trickles-Down Economics

The losers from low oil prices are mostly intuitive and easy to spot. Oil companies and oil-dependent governments have suffered the most from the drop in oil prices - BP Plc's (NYSE:BP) share price has fallen from $50 to below $30. Industries that rely on the oil industry, like exploration or oil-related manufacturing companies, have also taken a hit. Ironically, as oil companies have buckled, so have many sustainable energy enterprises. Low oil prices make conventional, non-renewable energy more appealing to consumers, and companies like Vestas (OTCPK:VWSYF), the only company that focuses nigh exclusively on wind energy, and Tesla (NASDAQ:TSLA), the famous maker of electric cars, have suffered the consequences.

The winners are equally intuitive. Airlines benefit from lower fuel prices, and as consumers have more incentive to buy less fuel-efficient vehicles, truck and heavy automobile manufacturers' revenues also increase. After all, everyday drivers feel less of a pain when they fill up at the pump.

The oil companies that dominate parts of the global economy may be far away, but oil's impact hits right at home.