Posted By The Bank for International Settlements
Since mid-2014, after remaining relatively stable for four years at close to $100, the price of crude oil has dropped by roughly 50% in US dollar terms.1
Changes in production and consumption seem to fall short of a fully satisfactory explanation of the abrupt collapse in oil prices. The last two episodes of comparable oil price declines (1996 and 2008) were associated with sizeable reductions of oil consumption and, in 1996, with a significant expansion of production. This seems to be in stark contrast to developments since mid-2014, during which time oil production has been close to prior expectations and oil consumption has been only a little weaker than forecast (Graph 1, left-hand panel). Rather, the steepness of the price decline and very large day-to-day price changes are reminiscent of a financial asset. As with other financial assets, movements in the price of oil are driven by changes in expectations about future market conditions. In this respect, the recent OPEC decision not to cut production has been key to the fall in the oil price.
However, other factors could have exacerbated the fall in oil prices. One important new element is the substantial increase in debt borne by the oil sector in recent years. The greater willingness of investors to lend against oil reserves and revenue has enabled oil firms to borrow large amounts in a period when debt levels have increased more broadly. Issuance by energy firms of both investment grade and high-yield bonds has far outpaced the already substantial overall issuance of debt securities (Graph 1, right-hand panel).
This post was published at David Stockmans Contra Corner on February 7, 2015.
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