Vanguard : Is the barrel half empty or half full?

Oil prices have tumbled dramatically, falling from $110 a barrel in mid-2014 to below $30 last week. Investors are wondering what might be driving this fall. There are three key factors that drive the price of crude oil :

1. oil supply (both current inventories and future supply expectations),
2. demand (expected global economic growth), and
3. strength of the U.S. dollar (affecting benchmarks priced in U.S. dollars).

The degree to which each factor moves the dial on oil price can shed light on how the global economy might be affected. For example, large supply-driven changes in oil prices may have a positive effect on oil importers' economic growth via increased consumer spending.

The most recent oil-price decline, starting from June 2014, is driven largely by increasing supply in the market, while the negative impact from slowing global demand has increased recently. Because oil is priced in U.S. dollars, the strengthening of the dollar has weighed on oil prices, but to a lesser extent recently as appreciation of the dollar has slowed.

Overall, the global economy should benefit from low oil prices. Most developed countries (except for a few such as Canada and Norway, which are net exporters) and some emerging economies (such as India, China, and Poland) are net importers of oil, and they benefit from lower prices.

Emerging markets (such as Saudi Arabia and Kuwait) that depend heavily on oil exports, are more exposed to the negative growth and budgetary implications of a price drop, particularly those already in precarious macroeconomic situations such as Venezuela, Russia, and Iran.

Note:

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