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Salt Creek Oil Field

Early oil gusher, Salt Creek Oil Field. (Art Randall Collection, Casper College Western History Center)

OK, so you know oil prices have lost more than half their value since the summer. And you've likely heard it blamed on Saudi Arabia and, by extension, OPEC's decision not to cut production. 

But there's a lot more to the story than that. In fact, you could probably write a book on the subject. We don't have space for that, so instead we'll provide what might be considered an introduction to crude's current collapse.

Q: Why were prices so high to begin with? 

A: West Texas Intermediate, the American benchmark for crude, was on a record run before it hit the skids in June. Between 2011 and 2013, annual crude prices never averaged worse than $94 a barrel, according to the U.S. Energy Information Administration. 

To put those numbers in context: 2008 is the only other year WTI averaged better than $90 a barrel. Heck, before 2005, WTI never crested above $55 a barrel. 

All of which is to say $90 oil is an anomaly, historically speaking. 

The high prices of recent years owe themselves in large part to simple supply and demand. Emerging economies like China, India and Brazil were growing at a steady clip between 2011 and 2013, and each fueled its expansion by consuming more oil. 

In 2013, for instance, total global production was 90.9 million barrels a day. Total consumption was 91.24 million barrels a day. In other words, the world was using more oil than it produced. 

"For much of the 21st century, the big story was emerging demand in China. The growth in personal vehicle ownership, for example, has been nothing short of explosive," said Charles Mason, a professor of petroleum economics at the University of Wyoming. "The implication of this strong and steady growth in Chinese demand has been persistent increases in the force to push prices up."

Q: When people talk about falling oil prices they always bring up Saudi Arabia and OPEC. Are they responsible for crude's decline?

A: Saudi Arabia has certainly played a role. The country's oil minister, Ali al-Naimi, announced in November that OPEC would not be cutting production in response to low prices. The announcement sent crude prices tumbling to their lowest level in four years. 

But crude prices had already been sliding by that point. Chinese growth slowed, Japan's economy began to decline, as did Europe's. By mid-2014, the world economy was showing real signs of slowing down.

"That was when you started to see downward projections in oil demand growth," said John Saucer, an analyst at Mobius Risk Group in Houston. "I think they (Saudi Arabia) got sucked into it after the ball was rolling."

At the same time, surging production in North America helped global supply surpass global demand. The result: a glut of oil that pushed prices down further.  

Q: OK, so Saudi Arabia is just one factor. Still, why aren't they cutting their production? They're an oil-producing country. Shouldn't they want prices to go up? 

A: It's true the Saudis want to protect their market share from U.S. shale producers and that low prices hurt their rivals Russia and Iran. 

But that's only part of the story, Saucer said.  

The Saudis are more concerned about losing market share to other forms of energy like solar than other oil producers. They also don't want to see enhanced energy efficiency measures eat into demand. Higher oil prices make alternatives and energy efficiency more attractive, Saucer said. 

"They have a lot of oil in the ground. They want to be selling it for 50, 60, 70 years," Saucer said. "They don’t want to go the way of whale oil."

A period of low oil prices can also serve as a shot in the arm for the global economy, helping to boost demand worldwide for crude.

So while low oil prices may hurt the Saudis in the short-term, they could serve the country's interest in the long-term.

Q: When will the market start to turn around? 

A: There really isn't an answer to this question, just a bunch of semi-informed guesses. A lot will depend on what happens with the global economy and whether Europe and Japan can record strong periods of sustained growth. 

Many analysts are also watching the supply side. U.S. production is expected to peak sometime in the middle of the year, as all the oil from newly drilled wells is brought on the market. But production growth will likely fall quickly after that due to declining output of shale wells and the sharp curtailment of drilling rigs nationwide.

At that point, "international players -- investors, big oil development interests -- will shift from expecting sluggish conditions to expecting prices to rise," Mason said. 

Another important indicator will be refinery demand. Refineries in the U.S. generally shut down for maintenance during the first three months of the year and fire back up again in March. Low crude prices mean refineries stand to make a lot of money and will likely be running at full capacity. 

"The refinery demand should help underpin and lift the value of the crude being sold by producers in Wyoming," Saucer said. "It doesn't mean they will bring rigs back on line, but it certainly puts themselves on a path when those sort of activities recommence. It will still take a while."

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Reach energy reporter Benjamin Storrow at 307-335-5344 or Follow him on Twitter @bstorrow


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