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A look at falling oil prices

Hydrocarbon Engineering,

According to the Institute for Energy Research (IER), crude oil prices have fallen approximately US$ 40/bbl, more than 35%, just since June.

Although the recent drop in crude oil prices has been significant, some analysts are treating it as if it were unprecedented. However, these movements are not so rare. Although the recent drop is relatively large, there have been three comparable falls just since 2006. Furthermore, none of these four episodes comes anywhere close to the utter collapse of crude oil prices in 2008.

Robert P. Murphy of the IER suggests that the Federal Reserve perhaps played a role in the current oil price decline. In May 2011, Murphy testified before a Congressional subcommittee on the role that the Federal Reserve’s ‘quantitive easing’ programs might have played in pushing up oil prices (and hence gasoline prices). He explained that when the Fed effectively flooded the financial markets with trillions of new dollars, this would make the dollar weak against other currencies and cause some investors to flee to commodities as an inflation hedge. Thus, the Fed’s loose monetary policies would have a strong effect on prices quoted in US dollars.

Murphy does not think that it is a coincidence that the recent plunge in crude oil prices occurred as the Fed wrapped up it’s ‘tapering’ process and formally ended what the financial analysts had dubbed QE3 (the last official purchase of Treasuries and mortgage backed securities occurred in October, and now the Fed is holding its balance sheet at a constant size).

As the markets reacted to continued signs from the Fed that it was indeed ending the infusion of more dollars into the system, the US$ strengthened against other major currencies. The Fed’s actions may also have had an effect on investors who were piling into commodities for inflation protection.

In support of this theory is the fact that gold prices are also falling (down approximately 10% since June). Not such a big drop as crude oil, but it does show that the fall in crude may be part of a larger story, and is not merely due to particular development in US tracking and/or Saudi Arabian strategising.

Adapted from a press release by Emma McAleavey.

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