The Emerging World of Cheap Energy

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The Emerging World of Cheap Energy

Turmoil in Iran. Terrorist threats from ISIS. Fears of a global Ebola pandemic originating in Africa. In recent years, such geopolitical events would have caused oil prices to skyrocket, leading to inflation, a drag on GDP, and misery for consumers at the gas pump.

But that's not what has happened. In fact, gas prices have plunged to less than $3 a gallon in most U.S. markets, as the price of oil has gone down dramatically in recent months. In early November, the price for a barrel of U.S. crude dropped to $75.84 before closing at $77.19, the lowest closing price in three years. The U.S. benchmark, West Texas Intermediate (WTI) crude, dropped nearly 30 percent from the price of just under $108 per barrel in June. Meanwhile, Brent, the international benchmark, closed at $82.82 after dipping to $82.08, its lowest price in four years.

This decline in prices isn't temporary. Goldman Sachs recently lowered its price forecasts by an average of $15 per barrel for 2015. Its analysts now predict that WTI crude will fall to $75 in the first quarter and $70 in the second quarter, while Brent will drop to $85 in the first quarter and $80 in the second quarter.1

Why are oil prices falling? There are two very important reasons.

The first reason is that demand is not increasing as quickly as expected. Compared to last year, demand has only grown an average of 630,000 barrels per day, which is less than half the growth Goldman had predicted.

Over the long term, OPEC expects global oil demand to increase by roughly 21 million barrels per day, to 111.1 million, by 2040. However, all of that growth is expected to come from developing economies. OPEC predicts that the developed economies in the OECD will actually reduce their demand by more than 7 million barrels per day.

The second reason is even more important: The U.S. shale revolution is rapidly increasing the supply. While increased drilling in the Gulf of Mexico accounts for some of the increase, most of the growth is due to the use of hydraulic fracturing and horizontal drilling to extract shale oil from vast deposits that lie beneath such states as North Dakota and Texas. U.S. oil production recently reached 8.97 million barrels per day; that's the highest level of domestic crude oil production in the 32-year history of the U.S. Energy Information Administration's Weekly Petroleum Status Reports...

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