Why Oil Is at 4-Year Lows

The drop in oil prices has been driven in part by booming production from U.S. shale plays, primarily in North Dakota and Texas. Technology perfected over the last decade has made it profitable to drill wells in shale formations that we’ve known about for decades but couldn’t exploit, leading to more domestic production than at any time since 1986.

Rising U.S. production has made us less reliant on OPEC, the 12-country oil cartel that’s long controlled the price of oil. In 2008, 30.5 percent of all oil consumed in the U.S. came from OPEC, and now that figure is down to 17 percent, as of August. With production having increased here and in locations like Brazil and Russia, OPEC has far less control over the price of oil.

While supply keeps rising, demand is shrinking in much of the world. The U.S. and Europe have been lowering oil consumption for a decade and China’s growth appears to be slowing, making for only slight growth in oil demand globally.

Put it all together and you have about 2 million more barrels of oil than the world needs every day. At some point, prices had to come down, and reality has hit the oil market like a rock in 2014.

How Low Can Gas Prices Go?

The next question is: How low can gas prices go if oil prices are plunging?
Historically, the price of gasoline should follow oil lower, and that’s exactly what we’re seeing today. But gasoline costs will only go as low as oil.

In late 2008, when the recession was taking its grip on the U.S., West Texas Intermediate oil fell to just over $30 a barrel and hovered around $40 for most of the first quarter of 2009. When oil bottomed, the price of gasoline fell to $1.59 a gallon for a short time, but when it recovered to $40, it hung just below $2 a gallon.

In today’s market, that’s the low end of where I think gasoline prices can go, because oil drilling will simply shut down if the price of oil falls below $40. On a localized basis, prices could go as low as $1.50 a gallon, but not for long. At that price, explorers, drillers, and refiners won’t have enough profit to make energy production worth their time.

Enjoy Low Gas Prices While They Last

There are a lot of oil-producing companies and entire countries that are panicking right now over the price of oil — and it’s at $60 a barrel. Sometime next year, some of them will be forced to lower production and bring supply back in line with demand, raising prices for everyone. There’s just too much at stake economically for prices to stay this low for long.

I don’t think $4 gasoline will be back anytime soon, but we should enjoy low gas prices while we can. I wouldn’t be surprised if by next holiday season they creep back toward $3 a gallon from the valleys near $2 today.

Travis Hoium is a Motley Fool contributing writer. Try any of our Foolish newsletter services free for 30 days. Want to make 2015 your best investing year ever? Check out The Motley Fool’s one great stock to buy for 2015 and beyond.