Why Are Oil Prices Dropping? OPEC Bows To Global Pressure To Increase Oil Supply

Update 08/31/2022

In the original article below we covered OPEC’s increase in production, and explained how this was likely to help prices fall over the coming months. Well, that’s exactly what’s happened.

Since early March, the price of West Texas Intermediate has fallen over 30% from a high of $129.44 down to the current price of just under $90.

It’s not just increased supply that has caused oil prices to fall, it’s also the general economic environment. Oil is used widely in both the manufacture and transport of goods, so a booming economy often walks in step with a high oil price.

Given that economic growth is low right now, demand for oil has been decreasing and this, combined with the increase in supply has taken the pressure off prices.

We’re noticing the different at the last station too, with prices dropping steadily around the country since early June.

If you want to learn more about OPEC and how the oil cartel’s decisions impact global markets, as well as what this means for investors, read on.

Key Takeaways

• The price of crude oil continues to rise and hit new highs on the back of significant demand post-Covid19
• OPEC has agreed to increase their oil output to 648,000 barrels a day, up from the 432,000 barrels expected
• The 50% increase will likely help moderate prices in the short term
• OPEC has been under pressure to increase the supply above these estimates to allow for greater sanctions on Russian oil

Following a bumpy start to the week, oil prices rose before Thursday’s OPEC meeting, with U.S. oil reserves falling more than expected. After a flash crash at the beginning of the Covid-19 pandemic that saw the oil price briefly go negative (yes, really), it’s been marching upwards steadily since. This hasn’t gone unnoticed by car owners, with prices at the pump seeming to hit new highs on a weekly basis.

We’re in this mess partly due to the unusual supply and demand dynamics experienced during the early days of Covid-19. With lockdowns enforced worldwide and global travel effectively halted, the oil demand dropped almost overnight.

Many oil producers adjusted, and now that life is returning to normal, they’re struggling to keep up. The problem is exacerbated by the same supply chain and employment issues facing many other industries, with U.S. energy producers finding it difficult to increase production to meet demand.

With Russia being a major oil exporter, particularly to the rest of Europe, the war in Ukraine also has a significant impact. Just this week, the European Union finally agreed to a partial ban on Russian oil after many months of discussions and negotiations.

At Thursday’s meeting, OPEC ministers set their oil output targets for July. They’ve been under pressure from President Biden and UK Prime Minister Boris Johnson to increase supply to allow for more significant sanctions on Russia. This may have had an impact, as OPEC ministers announced an increase in supply to 648,000 barrels a day, a 50% increase from the expected 432,000 barrels a day.

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Who is OPEC?

So if the demand is there and the price is high, why don’t oil producers compete with each other to eat up the excess demand? It’s because OPEC is an oil cartel that cooperates on pricing to ensure its members’ best long-term financial outcomes.

OPEC comprises thirteen countries that control an estimated 81.5% of the world’s proven oil reserves, giving them tremendous power over oil prices. OPEC members agree on the supply level to provide to the market, and these quotas are decided on at the OPEC meetings.

This level of cooperation and gaming of the free market is generally illegal, as it reduces competition and disadvantages the end consumer. However, OPEC can operate this way because the arrangements have been entered into by the governments of the member countries. This means they don’t fall under the antitrust jurisdiction of any other country.

OPEC is increasing supply above previous estimates

It might seem counterintuitive for an organization – whose sole purpose is to maximize the profits of its members – to increase supply when prices are at record highs, as it’s likely to take the heat out of prices. The reality isn’t as straightforward.

While OPEC does want a high oil price, they also don’t want it too high. The current situation is a great example. The cost of living is increasing rapidly around the world, with record-high inflation experienced in many countries. Gasoline, a direct byproduct of oil, is no exception to this, with many of us feeling the pinch at the pump.

There are levels of price increases that consumers can take on the chin, but at a certain point, it all gets a bit much. If the cost of a tank of gas goes up by 15%, we’ll feel its impact, but it most likely won’t change our driving habits.

If the cost of gas goes up 150%, riding the bus or buying an electric scooter might start to look a lot more attractive. This is the tightrope that OPEC aims to walk; Keep the price high enough for them to reap healthy profits whilst minimizing the impact on demand.

This is a major reason why they have approved the increase to 648,000 barrels a day in July. Supply from OPEC has been steadily increasing since September 2021 and is expected to continue for some time.

What does this mean for investors?

Because oil prices are so high, they create a significant boon for producers. So far this year, BP’s stock price has risen almost 25%, Chevron is up nearly 50% and ExxonMobil is closing in on a 55% gain.

You may find it surprising how many companies are impacted negatively by high oil prices. There are obvious ones such as airlines and trucking companies, but oil is widely used in many different industries from food production, clothing and consumer goods, construction and manufacturing.

And of course, for companies producing physical goods, transporting the finished product will usually rely on gasoline. As with almost any specific financial event, there are sectors and companies that will benefit from it and others that will suffer as a result of it.

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