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Why oil prices are dropping down to $50 per barrel

The price of oil keeps falling and falling and falling. Back in June 2014, Brent crude went for $115 per barrel. That price has dropped in half, down to $53 per barrel. And it's still declining today.

I previously wrote an in-depth explanation for why oil prices are plummeting, but you can get a short version from the chart below by the International Energy Agency. The supply of oil keeps growing — thanks in large part to the US shale boom. Yet demand for oil keeps sagging, due to weak growth in Asia and Europe.

Basically, there's a lot more oil getting pumped out right now than anyone needs, and a lot is just getting stockpiled away for later. That's causing the price to drop:

(International Energy Agency)

This wasn't always the case. Between 2010 and 2014, oil consumption was rising steadily, but global oil production was struggling to keep up. Stockpiles were getting drawn down. That led to higher oil prices — around $100 per barrel — which spurred drillers in the US to extract more oil from shale formations in places like North Dakota and Texas. But that boom was partly offset by conflicts in oil nations like Libya and Iraq.

Since mid-2014, however, things have shifted. US oil production is still rising upward. Russia, Iraq, and Canada keep producing more oil too. Just as important, global oil demand has weakened unexpectedly, especially as economic growth in China and Europe have been slowing down. OPEC also played a role: at one point in November, onlookers thought that Saudi Arabia might cut back on its production to prop up prices. But the Saudis don't want to lose market share and have signaled that they won't make any cuts for the time being.

End result? Oil traders expect that the supply of oil will remain plentiful for the foreseeable future, while demand will remain weak — which is exactly what that IEA chart shows. And, since the price of oil is determined by contracts for future delivery, these expectations for the future matter a lot. That's why oil prices keep falling.

A lot of day-to-day price movements are related to this basic dynamic. On January 5, prices started falling yet again. Why? Because new data indicated that oil exports from Russia and Iraq were hitting record highs. And, even though lower prices may eventually kill some costly shale-drilling projects in the United States, overall US oil production is still expected to increase in 2015. That expected increase in production has been enough to offset the news of fresh conflict in Libya (which is taking a smaller amount of oil off the market).

In the meantime, few analysts expect growth to pick up in Europe or China or Japan anytime soon. So global demand is expected to remain sluggish in the near future.

That's the short version. Whenever new data shows an unexpected boost in oil production or an unexpected drop in oil demand, prices go down. For oil prices to go up, we'd need to see either an unexpected drop in supply — say, new fighting flares up in Iraq, or US shale projects start going offline faster than expected, or Saudi Arabia switches its stance and decides to cut back on output to prop up prices. Or we'd need to see a surprising rise in demand — say, China starts growing faster than expected or the euro zone somehow fixes its economic woes.

Further reading

-- Why oil prices keep falling — and throwing the world into turmoil

-- What the huge drop in gasoline prices means for America

-- Driving in the US has been declining for years. Will cheap gas change that?

-- How far do oil prices have to fall to throttle the US shale boom?

-- A look at North Dakota's efforts to prepare for an oil price bust

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