Oil and Gas Background
Oil prices and natural gas prices moved up dramatically during the early 21st century. From 1999 to 2008, the crude oil price spiked from under $25 per barrel to more than $160 per barrel. Rapidly increasing demand in emerging economies, such as China and India, and production cuts by the Organization of Petroleum Exporting Countries (OPEC) in the Middle East drove the price of oil to record heights. At the same time, natural gas spot prices went from under $3 per million BTU to over $12 per million BTU between 1999 and 2008.
Shortly after that, a deep global recession throttled demand for energy and sent oil and gas prices into a precipitous free fall. By the end of 2008, the price of oil had bottomed out at $53. The economic recovery that began the following year sent the price of oil back over $100. It hovered between $100 and $125 until 2014, and then it experienced another steep drop. Natural gas fell below $3 per million BTU in 2009, but it was up to $6 per million BTU by early 2014. However, natural gas prices declined sharply during that year.
- The rise of oil and natural gas prices in the early 21st century set them up for a fall in 2014.
- The shift toward a stronger U.S. dollar in 2013 also played a significant part in reducing oil and gas prices in 2014.
- An extended period of higher prices encouraged oil production, so there was an oil glut in 2014 after demand from emerging markets declined.
The U.S. Dollar
A stronger U.S. dollar was one of the principal reasons for plummeting natural gas and oil prices in 2014. Commodities are generally traded in U.S. dollars, which means there is a direct relationship between the dollar and oil prices. The U.S. Federal Reserve (Fed) decreased the value of the dollar to deal with issues in the U.S. economy in the early 21st century. The first interest rate cuts were aimed at reducing the impact of the collapse of the dotcom bubble and the 9/11 attacks. The rate cuts limited damage to the stock market by weakening the U.S. dollar, but that also increased the prices of most commodities in U.S. dollar terms. The Fed pushed interest rates to zero during the 2008 financial crisis and then engaged in quantitative easing to further reduce the value of the dollar. Markets were restored again, but commodity prices started to go back up.
Anticipating the strength or weakness of the U.S. dollar can make a big difference to investors. A weak dollar favors commodities and emerging markets, while a strong dollar favors U.S. stocks and bonds.
In 2013, the Fed finally changed course and began a period of strengthening the U.S. dollar. The first event was the taper tantrum that sent Treasury yields higher after the Fed reduced the pace of quantitative easing. Initially, many investors were skeptical that the Fed would stick to a course of tighter monetary policy. By 2014, the change in the tide became clear. Prices for many commodities, including oil and natural gas, began to fall. The Fed steadily tightened monetary policy until starting rate cuts in 2019.
The 2014 Oil Glut
Numerous specific factors contributed to the 2014 drop in oil prices. Economies such as China, where rapid growth and expansion created an unquenchable thirst for oil in the first decade of the new millennium, began to slow after 2010. China is the world's largest country by population, so its lower oil demand had significant price ramifications. Many other large emerging economies experienced similar economic trajectories in the early 21st century. They had rapid growth during the first decade, followed by much slower growth after 2010. The same countries that pushed up the price of oil in 2008 with their ravenous demand helped bring oil prices down in 2014 by demanding much less of it.
Spurred by the negative effect of high oil prices on their economies, countries such as the U.S. and Canada increased their efforts to produce oil. In the U.S., private companies began extracting oil from shale formations in North Dakota using a process known as fracking. Meanwhile, Canada went to work extracting oil from Alberta's oil sands, the world's third-largest crude oil reserves. The two North American countries were able to boost their oil production sharply, which put further downward pressure on world prices.
Saudi Arabia's actions also contributed to the 2014 oil glut. The country was faced with a decision between letting prices continue to drop or ceding market share by cutting production to increase prices. Saudi Arabia kept its production stable, deciding that low oil prices offered more of a long-term benefit than giving up market share. Saudi Arabia produces oil very cheaply and holds the largest oil reserves in the world. So, it can withstand low oil prices for a long time without any threat to its economy. In contrast, extraction methods such as fracking are more expensive and not profitable if oil prices fall too low. Saudi Arabia hoped that other countries, such as the U.S. and Canada, would be forced to abandon their more costly production due to lower prices.