Oil will flow like milk and honey. Here’s why — John Reilly

MIT Sloan Sr. Lecturer John Reilly

From USA Today

The price of oil has fallen nearly 60% since peaking in June, and lately there’s been a lot of ink and pixels devoted to the question of whether oil prices will plunge even further or whether they will shoot right back up. An even bigger issue is whether prices will stay at these very low levels.

While I doubt oil prices will fall much more — how much further could they reasonably tumble? Perhaps another $20 or so? — history suggests we can expect prices to remain low for the foreseeable future. What’s playing out right now in the oil market is likely the same supply-demand dynamic we’ve seen over and over: several years of extremely high oil prices followed by decades of low prices. The twin oil shocks of the 1970s, for instance, resulted in 20 to 25 years of low prices.

Of course, things are different today — but not that much different. Over the past six or seven years, oil has been relatively expensive, often trading at over $100 a barrel. During that time, both the supply and demand sides of the equation have responded.

On the supply side, high prices have spurred investment in oil and gas exploration.Even as OPEC (Organization of the Petroleum Exporting Countries) has maintained steady production, the U.S. is experiencing a drilling revival and the shale industry is booming. Oil production is up in other countries, too. Canada has boosted its crude oil production, as have Russia and Libya. With more oil on the market, prices predictably have fallen.

On the demand side, many developed countries — including the U.S. — are using less oil.Policies such as CAFE (Corporate Average Fuel Economy) have helped improvethe fuel economy of cars and light trucks. Consumers, meanwhile, have recentlydemanded higher-mileage cars.

There are sociological forces driving oil prices down, as well. For instance, people aremore likely to live in cities (rather than car-critical suburbs) and choosing to walk or bike more.

Read the full post at USA Today.

John Reilly is the Senior Lecturer and Co-Director of the Joint Program on the Science and Policy of Global Change at the Center for Energy and Environmental Policy Research (CEEPR) at the MIT Sloan School of Management.

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