Why oil prices are plunging - again

Photo / Bloomberg

Despite sharply rising tensions in the Middle East, oil prices had seemed fairly stable - if quite low - as 2016 began. But that all changed Wednesday, as prices suddenly plunged, falling as low as $34.26 per barrel for Brent crude, a global benchmark.

To find previous closing prices this low for Brent, you have to track back 11 years, to 2004.

In other words, a barrel of oil today is now considerably cheaper than it was even during the 2008-2009 financial collapse.

"I think traders are looking for the bottom of the market, and they really want to know when it's going to arrive and how they are going to know it's there," said Sarah Ladislaw, director of the energy and national security program at the Center for Strategic and International Studies.

Immediate catalysts driving markets on Wednesday include North Korea's claim to have tested a hydrogen bomb - raising geopolitical fears - and concerns about China's currency, the yuan.

"We're seeing very little pullback in production, and headlines out of China, which has really been the growth driver for years, continue to be pretty negative," said Brian Youngberg, an oil analyst with Edward Jones.

On Wednesday the U.S. Energy Information Administration also released new data on U.S. crude oil inventories for last week. Inventories were at 482.3 million barrels, "near levels not seen for this time of year in at least the last 80 years," the agency said. Gasoline inventories, meanwhile, increased by over 10 million barrels.

In truth, the broader oil story is not much different than it has been for many months - there is too much oil supply on the market, because OPEC has declined to cut production, pursuing a Saudi-driven strategy to maintain market share. So instead, markets must wait for lower prices to be reflected in decreased production across the entire sector, a process that has been a slow grind overall.

Global crude inventories continue to swell as supply outpaces demand, and rather than threaten crude supplies in the Middle East, the growing Iran-Saudi tensions may have eliminated whatever chance existed that OPEC would cut production.

In the meantime, U.S. consumers are reaping some pretty clear benefits, overall, from low oil prices. Extremely cheap gasoline has helped fuel a record year for car sales in 2015 and also a 3 percent rise in gasoline consumption. Both developments have environmentalists and those worried about climate change concerned about how low oil prices are actually encouraging more consumptive behaviors that ultimately put greenhouse gases in the atmosphere.

And the outlook, for now, may well be more of the same in the coming months.

"We have not seen the bottom obviously. We are close, but we have been close to the bottom for the last six months," said Fadel Gheit, an oil analyst with Oppenheimer and Company.