Since the beginning of this year and until mid-May, the oil price was in a kind of hibernation: the price of a barrel of black gold barely moved and was around $55 dollars a barrel. At the end of May, the price dropped. Since then, the price has only fallen.
A barrel of oil now costs just under $45 a barrel. That is a sharp drop in a few weeks. Just like any drop in any price, this one too is caused either by a slump in demand or an additional increase in supply, which has thrown the balance between supply and demand out of balance. A combination of both, a lower demand and at the same time an increased supply, can of course also be the cause.
Exact reason?
It is important to know the exact reason. If the cause is on the demand side, that is bad news for the economy. After all, less demand for oil usually means that economic growth is also lower. That in turn increases the likelihood that the central banks will at least not tighten their monetary policy any further. In other words: the Fed will not raise interest rates any further and the ECB has another reason to keep its interest rate at 0% and to keep the large-scale buying of government bonds intact. The latter aims to keep long-term interest rates in the eurozone low.
off the lead
If the oil price fall is due to an increased supply of oil, the consequences for economic growth will be positive rather than negative. As the underlying economy grows, creating new jobs and rising wages, allowing consumers and businesses to spend more, the price of oil also falls. This can be seen as a kind of unexpected tax cut. This could give economic growth an extra boost. In that case, the central banks would have much less reason to keep the money tap open unchanged.
The New York Regional Central Bank's weekly oil market survey allows us to find an answer to that important question. This shows that by far the most important reason for the said price drop is a considerable increase in supply. At the same time, demand has also fallen somewhat.
This seems to have reversed the trend from the end of last year. In the last months of last year, the oil price rose from about $40 to about $55 per barrel. At the time, it was a combination of declining supply (due to the agreement between OPEC and non-OPEC countries to reduce oil production) and slightly rising demand due to economic recovery.
Too much offer
The experts at the New York Central Bank argue that too much supply has been the main factor driving the oil price since the summer of 2012. Too much oil on the market, despite OPEC countries' production agreements (we wrote earlier that OPEC countries indeed have a very poor track record of adhering to those agreements), oil price developments have dominated for some time, according to the New York Fed.
There is little evidence that this situation will change in the near future. It would not come as a surprise if central banks such as the Fed do not care much about the fall in the oil price. So there is a good chance that the central bank in Washington will raise official interest rates again this year or at least keep hinting at it for some time to come.
ECB wants to lower interest rates
In the eurozone, an interest rate hike is still a long way off. What could happen in the near future is that the beginning of the end of the ECB's large-scale purchase of government bonds from the euro countries is increasingly being taken into account. That could put some upward pressure on long-term interest rates, but it should be noted at the outset that there is a very good chance that this process will be slow, because the ECB does not want interest rates to rise quickly and sharply.