The drop in oil prices

Oil was discovered in Pennsylvania in 1864 and has been governed by supply and demand ever since. It has been considered, from its beginnings until today, a main economic indicator, showing levels and movements of the economy.

An example of the influence of the price of oil is the current situation of the economy. In March, Saudi Arabia and Russia began a price war in the oil market, adding to the economic impact caused by the COVID-19 pandemic, generating a historic drop in the price of crude oil: Brent Crude experienced a drop of up to 24.1%, its largest drop since 1991. But what is behind these figures? What is the influence or power of oil over the economy?

Oil and its influence on the economy

This natural resource known as “black gold” is one of the main generators of energy, and the world and its economy are powered primarily with that energy. Oil generates approximately, according to the state of the economy, about 2.5% of the world’s Gross Domestic Product (GDP), and contributes almost a third of the total energy used on the planet.

The availability of this resource and its variation in price can affect many countries’ ability to run smoothly, not only those of oil producers. We must keep in mind that transportation (cars, trucks, planes, buses, etc.) largely run on oil. But its uses go beyond that:

  • Energy. It is a fossil fuel that directly generates energy used in transportation, industry and agriculture. It is also an electrical energy generator for industrial and domestic use.
  • Petrochemicals. From this resource, products such as insecticides, paints, textiles, plastics and containers, among others, are manufactured. Together with gas, it is the main producer of the plastics we use every day.
  • Special products for industrial use. Lubricants and oils for vehicles, asphalt and paraffin.

This is how the drop in oil prices affects economic activity

On the global level, there is the so-called Organization of Petroleum Exporting Countries (OPEC), formed by 14 countries that represent 30% of world production, with Saudi Arabia at the head as the main producer. In second place is the United States, leaving the third place for Russia. These countries have the power to set the price and production levels of oil at will. If demand is high, prices go up, while if it goes down, production goes down so as not to lose money.

The most important oil companies in the world are located in the United States: ExxonMobil and Chevron are the best known. In the second quarter of this year, they experienced losses of $9.3 billion due to the impact of COVID-19 on the demand for raw materials. The drop in sales was over 50%. On the other hand, the price of Texas crude has recovered slightly, but it is far from the price it had reached at the beginning of the year (34% less) . In April of this year, and for the first time since the Gulf War in 1991,US oil plummeted and traded below zero: $-37.63 USD per barrel of US oil [West Texas Intermediate (WTI)]. This drastic fall, which caused a great worldwide stir, was caused by the reduction in energy demand as a result of confinement and the general state of alarm around the world.

In the case of importing countries, the drop in prices is good news and boosts the economy, as is the case in Spain. When oil is cheaper, it increases the real disposable income of families, so it supports aggregate consumption. Similarly, the decrease in production costs also favors investment.

In Europe, the price of Brent Crude —the indicator price here— increased dramatically on July 21, reaching $44.32 a barrel, the highest since the beginning of March, though it did experience fluctuations in subsequent days.

This year will leave a permanent mark on our retinas, and also on the economic data that experts have not yet been able to see clearly. In addition, the state of alarm and its stranglehold on industrial activity, and the decline in transportation threatened the recovery that was in progress. The social, economic and political instability there has been will have consequences for the economy and for oil that are still unknown.