Crude oil: U of I expert discusses roller coaster ride of prices

From the University of Illinois News Bureau

Editor’s note: The roller coaster ride of crude oil prices continues: After hitting triple digits in early summer, the price of a barrel of oil has decreased dramatically — and continues to fall by the day.

Don Fullerton is the Gutgsell Professor of Finance and an energy policy expert at Illinois. Fullerton, also associate director of the U of I Institute of Government and Public Affairs and a faculty associate with the Center for Business and Public Policy in the College of Business, spoke with News Bureau Business and Law Editor Phil Ciciora about what falling crude oil prices means for consumers as well as the global economy.

Phil Ciciora (PC): How did we get to crude oil prices in the mid-$60s from more than $100 per barrel in six months?

Don Fullerton (DF): Because crude oil is readily transported from Saudi Arabia to China, or from Alaska to Brazil, prices are determined on a world market. That price can change with any shift either in total worldwide supply or total worldwide demand. Oil prices fell in 2008 with the drop in demand from the Great Recession, but then prices rose with subsequent growth — especially in China. The June 2014 price was $106 per barrel, but only six months later is now at $66. Why? The primary reason is the increase in supply from new technologies, especially in the U.S. and Canada. Oil companies can now produce crude oil from tar sands in Alberta, and they can reopen old oil fields in the U.S. to squeeze out even more oil using new technologies like hydraulic fracturing.

PC: Do you foresee the trend of cheap oil continuing?

DF: That would be nice, and it’s possible that prices will continue to fall. Unfortunately, I can make no such prediction. The reason is that all available information about the likely future supply and likely future demand for oil are already built into the current world market price. If people “knew” that the price of oil was going to fall, then producers would put more oil on the market now while the price is higher than it would be in the future. But the very act of putting more oil on the market drives down the price now instead of later. Conversely, if anybody “knew” that the price was going to rise, then producers would hold some oil off the market, driving the price up now, instead of later.

Those most knowledgeable about oil markets have already reacted to any information about future events, and none of the rest of us knows any better than them.

PC: What will it mean for gas prices, consumer wallets, the environment and the global economy?

DF: The world market price of oil is, of course, the single biggest determinant of gasoline prices at the pump, so falling oil prices means falling gas prices — in some places in the U.S., down to levels below $2 per gallon. That process is a bit slow and uneven, however, as local markets also depend on local supplies and distribution costs. But certainly the general decrease in gas prices is great for consumer wallets. It may well fuel a stronger economic recovery, both in the U.S. and around the world.

It’s actually pretty hard to complain, even if the price drop is temporary, except that a lot of my research has been on climate policy and the need to raise the price of fossil fuels to try to slow the emissions of greenhouse gases. Lower prices of fuel are not good for the environment.

PC: What does this portend for global economic growth?

DF: The drop in oil prices will have some adverse effects on the oil industry in all of the states from Texas northward to North Dakota. Canada will be affected, too. It will have adverse effects on oil-producing nations like Saudi Arabia, but especially on other poorer countries like Venezuela that rely on oil revenue. But all of the other sectors of most economies will benefit from lower energy costs.

Generally, the drop in oil prices will help the economy.

PC: What kind of global instability will be unleashed in petro-states like Venezuela and Russia, where oil dollars account for a good chunk of their budgetary projections?

DF: A sharp drop in oil prices would likely reduce living standards in some of those oil-producing countries, which could create political unrest and possibly lead to desperation moves by some of their leaders.

From the Dec. 24-30, 2014, issue

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