Falling oil prices

The story that has had the greatest impact on the world economy in the past 12 months has been the collapse in the price of oil. It is the primary input in almost every economy, any shift in price has far-reaching effects.

But the reasons for the decline of oil, which saw the price of Brent Crude fall to lows of $45/barrel at one point, are complex and reflect a shift in production dynamics within the industry. While the sluggish global economy consumed less oil than predicted last year because of a slowing China, the main reason for the collapse in oil prices is the oilmen of North Dakota and Texas.

Thanks to advances in drilling technology, oil speculators in the US are now extracting shale oil through fracking from enormous oil fields that were previously seen as unviable. Since 2010, these oilmen have completed circa 20,000 new oil wells (10 times the number in Saudi Arabia), which has increased US oil production by a third and reduced oil imports from OPEC producers by 50%.

With the increased supply of oil, many expected OPEC producers to cut production levels to push the price back up but the cartel has adopted a different strategy. The group has decided to maintain production levels in order to defend market share while at the same time attempting to put high-cost shale producers in the US out of business.

However, shale oil production is a relatively young technology and it is gaining efficiencies all the time, meaning the oilmen of North Dakota and Texas are here to stay. This means the fundamental economics of the oil industry are changing, shifting the balance of power away from OPEC and its control of high oil prices.

Europe’s energy supply

The EU is the largest energy importer in the world, importing 53% of its energy needs at an annual cost to the region of €400bn. The euro area is currently enjoying the windfall of the fall in oil prices, which acts like a wage increase to consumers leaving them with more money at the end of the week. Even as the dollar has strengthened against the euro, consumers are still reaping a net benefit from low oil prices.

The other major energy source imported by the EU is natural gas, with 23% of Europe’s gas supply coming from Russia. In February, the EU Commission approved proposals to establish a single European energy market, a plan that would give the Commission more influence to negotiate gas supply contracts as a single entity. The Energy Union plan is also partly designed to reduce European dependence on Russian gas, particularly given the tensions that exist at present between Moscow and Europe.

While oil and gas will continue to be the major energy sources into the future, the development of renewable energy technology is likely to continue at a greater pace than ever before. For instance, the state of California has set ambitious targets for the coming years, aiming to produce 33% of its electricity from wind, solar and other renewable sources by 2020. California is already producing more than 5% of its electricity from solar power, with seven new solar power plants brought online in the last 12 months.

The global biofuel industry is valued close to $100bn and is expected to grow in value to $180bn by 2022 thanks to the significant investment and expansion the industry has attracted in recent years, largely driven by government policy. But if oil prices remain at current levels, the economics of biofuel production are difficult to justify.

Read more from this year's KPMG/Irish Farmers Journal Agribusiness report here.