02/19/2016 03:47 pm ET Updated Feb 18, 2017

The Oil Crisis in Plain English

Oil prices hit a 13-year low this January at $26 per barrel, down from over $100 per barrel throughout most of 2014. Prices are low because of an oversupply of oil in world markets. Global oil supply exceeds current consumption demand by about 1.5 Million barrels per day.

For decades, Saudi Arabia ran the world's oil market and was the defacto leader of OPEC, the inter-governmental organization that accounts for a majority of the world's oil reserves. However, in recent years, the United States has surpassed Saudi Arabia, having become the top oil producer on the planet.The United States domestic oil production has gone up 68% in the past five years.

Another contributor to the oversupply issue is Iran. As western sanctions have been lifted, Iran has entered the market and is now producing 1.1 Million barrels per day. They previously announced that they will increase their output by 500,000 barrels per day. In a surprising act this week, Iran's oil minister, Bijan Zanganeh, announced that Iran could support any effort to stabilize oil prices, but has not expressed any clear plan or intention to cut supply.

With all of this going on, oil rich countries like Nigeria, Algeria and Russia are pleading with the Saudi's to reduce their supply in order to prevent a collapse in their countries.

Lower oil prices are known to be good for consumers and spending. If a consumer is spending less on gas, there is more money available to spend on other things. The problem, however, is that oil prices have gone so low, that it is deeply hurting world economies, affecting oil producing countries and countries that do not produce oil alike.

The question now is when will we see a bottom to the oil price free fall? Not any time soon.

Back in January, Russia announced that OPEC and non-OPEC countries were considering a 5% output cut across the board. This would solve many of our problems, but it does not seem likely or realistic because Saudi Arabia has no real incentive to cut supply at this point.

In Saudi, the Royal family controls the oil supply, and can supplement it in order to keep the business running. Ali al-Naimi, the Saudi Arabian Minister of Petroleum and Mineral Resources, has repeatedly announced (as recently as February 19th) that the Saudis will not be cutting oil supply and they will hold that position "forever". In fact, not only are they not cutting oil supply, they have actually increased their production in order to keep and gain market share.

There are a few outcomes that could lead to the bottom of the oil market, and all of them would involve an overall decrease in supply. One scenario could be when major businesses are driven out of the market. This means that oil will not reach a bottom until a major oil company is driven into bankruptcy, causing a massive decrease in the supply of oil. Another bottom could be an agreement between both OPEC and non-OPEC nations to cut supply, which is currently being considered, but seems unrealistic. Each business will have to downsize in order to meet the new supply, but it will be a way to keep everyone in business.


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