Oil Is In the Stupid Range Once Again

Oil price massive fall is not making sense once again. Crude oil price has fallen from around $107 per barrel to almost $51 per barrel and there are analysts who are now predicting crude oil price touching $20 per barrel. It sounds like 2008 once again. This time on the short side. In 2008, crude oil price starting climbing up and touched almost $150 per barrel. It didn’t make any sense then. It is not making any sense now if we think in terms of the supply demand equation. Econ 101 teaches that supply should equal demand in order to find equilibrium. Right now there is a supply over glut in the market.

“We don’t know how much lower oil can go,” Schork said. “It’s similar to 2008 when we knew oil at $120, $130 and $140 made no sense, but high prices became the reason for higher prices. It’s the same thing in reverse.” Schork also said oil’s price plunge is attracting many investors. “Bets for oil below $30 by June traded over 46,000 contracts over the past two weeks,” he said.

How do you explain the present dramatic fall in the crude oil price? Perhaps thinking in terms of the game theory and modelling the oil market as an oligopoly can help us understand what is happening. There are a few players in the market who are behaving irrationally. The major player who is playing irrationally is Saudi Arabia. Saudi Arabia says it won’t cut its oil production. If Saudi Arabia doesn’t cut oil production, oil price will definitely hit $30 per barrel and may even touch $20 per barrel. In the long run, oil price will most probably stabilize in the range of $70-$80 per barrel. But during the intervening period when this battle for market share continues, many players will be seriously hurt. That includes Russia that has seen its currency Ruble facing 50% depreciation. Saudi Arabia will also be a loser. Its economy is heavily dependent on oil money almost something like 90%.  With it’s oil revenues dwindling it can face serious budgetary problems in financing the subsidies to its population that can result in social unrest. The US shale oil companies will also face many bankruptcies. It will be like the Dot Com Bubble once again. Only the strong players in the market will survive.