Oil Prices Fall as Economics Trumps Geopolitics

With drop in oil prices, US may be able to wield an “oil weapon” directly rather than using Saudis as surrogates. The economic impacts of the oil price slump on the global macro-economy are multiple, complex and conflicting.

Posted on 12/9/14
By Barry Naughten, Australian National University | Via The Conversation
(Photo via Satorp)
(Photo via Satorp)

As at early December, the international price of crude oil is around US$70 a barrel, depending on grade.


Over the last six months, oil prices have slumped by 30% and crude oil is now at its lowest level since mid-2010.


Recently OPEC members elected to ignore this price slide and chose not to cut production.


What drives oil prices?

Despite this recent price slump, oil prices remain within a historically high band. This price surge started in around 2003 and reflects the persistent long-term growth of the key oil import markets of China and India.


The price surge was only briefly interrupted in the immediate aftermath of the financial crisis due to negative economic conditions. At this time, in December 2008, the Brent spot price briefly dropped to US$34 a barrel.


Regional contingencies like wars and civil strife also influence oil prices. However, there is some room for deliberate policy influence, notably by OPEC members, which produce 40% of the world’s oil supply. These countries also produce a much higher global proportion of oil with very low production costs.


Since the OPEC crisis of the 1970s, OPEC, especially the key “swing producer” Saudi Arabia, has used its surplus capacity to influence price. The OPEC cartel is clumsy, however, given that some member states have an incentive to “cheat” by exceeding their authorized production quotas.


The fallout from OPEC’s decision to maintain production

At its meeting in late November this year, OPEC effectively endorsed the position of its so-called oil price “doves” (Saudi Arabia, UAE and Kuwait) that there be no attempt to cut output levels. A cut in output would act to reverse the recent price erosion. OPEC’s decision was to retain the aggregate production target of 30 million barrels a day – a level that was agreed back in December 2011.


The November decision has been to the detriment of Russia, which is not an OPEC member but a major oil and gas producer and exporter, along with OPEC members Iran and Venezuela. Each of these oil price “hawks” is suffering from painful and potentially destabilizing major declines in petroleum export revenues.


Table 1 indicates two versions of a series of break-even points below which national oil producing states and their budgets suffer as the price of oil declines.


It remains to be seen whether oil prices at their current levels will limit Saudi Arabia’s considerable financial support to Egypt’s military regime and to Sunni elements in the Syrian civil war.


It is unlikely, however, that oil prices will continue to fall significantly in the medium term. Market-induced cuts to production by high-cost suppliers will limit further price declines.


For example, United States supplies of “tight oil” are said to be at risk once global oil prices fall below US$60 a barrel in terms of the current costs of existing operations or even US$90 a barrel in terms of investment in new projects.


The economic impacts of the recent oil price slump on the global macro-economy are multiple, complex and conflicting. Though not typical, the Australian case is illustrative. The windfall of falling oil prices reduces the cost of net oil imports and favors industries sensitive to transport costs. However, LNG exporters tied to lower oil prices may experience some reduced profits. Benefits to the oil-dependent Chinese, Indian and Japanese economies will also indirectly benefit Australian exporters of raw materials and energy-related commodities.


US petropolitics and US-Saudi alliance: perhaps over-blown?

Since the mid-1970s, geopolitical theories of oil price determination have relied on the notion that the US can influence Saudi Arabia’s “swing producer” capabilities.


This alliance dates back to US President Franklin Roosevelt’s historic meeting with Ibn Saud in 1945. It has been reflected in Saudi Arabia’s role in stabilizing oil prices in the mid-1980s and during the first Iraq war in the 1990s. However, the Saudi-OPEC role in reversing the dramatic collapse of oil prices in 1998 was a case of rectifying its failure to foresee the Asian economic crisis, and required no prompt from the US.


The Saudi failure to endorse production cuts at the November 27 OPEC meeting has been depicted as reflecting US wishes. Specifically, that the US might have wished to place continued pressure on the three “price hawks”, which also happen to be US adversaries.


However, OPEC’s own agreed rhetoric emphasized the need for OPEC to nurture a global recovery in the major oil import-dependent economies of China, India and Europe, to the advantage of major oil exporters.


The most important recent major development on the supply side of global petroleum markets is the US-based “revolution in non-conventional petroleum”, including fracking-based production of “tight oil” and shale gas.


Two geopolitical claims are made about this development, which supposedly allows scope for the US to reduce its entanglement with Middle East politics. The first is the claim it permits the US to pivot toward East Asia. This questionable aspiration is now being undermined by the Islamic State crisis in Iraq and Syria and the increasing tension between OPEC’s oil price “doves” and “hawks”, respectively led by (Sunni) Saudi Arabia and (Shia) Iran in particular.


The other claim is these new production developments will allow the US to wield an “oil weapon” directly, rather than through Saudi Arabia, through its supposedly enhanced control over petroleum markets. This is a prescription embraced in the US both by supporters of deregulating US petroleum exports and by foreign policy hard-liners.


However, current US pressure on the Iranian and Russian economies and their petroleum sectors has taken the form of selective and targeted economic sanctions rather than the less discriminating blunt method of undermining world oil prices.


The much celebrated US-based non-conventional petroleum industry also has a high cost structure. Commercially this industry favors higher oil prices just as much as price “hawks” such as Russia.


Barry Naughten is Energy political economist and international relations specialist at Australian National University

This article first appeared in The Conversation. Click here to go to the original.

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