Cheap Oil: The good, bad and ugly news

Cheap Oil: The good, bad and ugly news

The astonishing fall in the global price of petroleum – approximately 40% of its high water mark just a few months ago, prompts J. BROOKS SPECTOR to look more closely at the winners and losers as this price drop washes through the international oil market and affects individual nations and consumers around the world.

Around four decades ago, OPEC, the Organisation of Petroleum Exporting Countries, came into its own as an international nine hundred pound-gorilla in the room when it succeeded in goosing the price of petrol at the pumps onto its seemingly inexorable rise. In many countries, the supply of petrol actually began to shrink – producing the frightening spectacle of long, long queues of automobiles waiting for a chance to fill up their fuel tanks. In the US and elsewhere, this development helped fill people with a kind of existential dread that this was a kind of trial run for the “End of Days” of civilisation.

Thinking back, when this writer first arrived in South Africa in 1975, he was not yet fully aware of just how tight the petrol supply had become, along with limited operating hours for petrol stations and no weekend service. (In fact, he once left his car parked outside the house one night and found that someone had come by in the dead of night to siphon out nearly all the petrol from the fuel tank. People weren’t so worried about car theft, but fuel pilfering was something really serious.)

This time around, however, after a price escalator that seemed only to be travelling ever upwards, the price of a barrel of Brent crude petroleum has now swiftly fallen to levels last seen many years earlier. And, so far at least, the emergency stop button doesn’t seem to work. Of course, while some are delighted with this outcome, there are others who have a slightly different view on the matter.

At the macro-level, the newest drop in oil prices can be read as a sign of weakness in the global economy and it will have some real impacts on governments that are – or are increasingly becoming – dependent on oil revenues. On the other, in countries where the price of petrol is not subsidised substantially at the point of sale, this price drop should put more money in consumer pockets and also lower operating costs for many businesses – from agriculture to airlines.

Much of the most recent drop in the price for crude has come as OPEC decided to keep its production target at 30 million barrels a day for all of its member nations. As the price continues to fall, it is increasingly apparent member nations of this producers’ cartel are increasingly concerned they will lose market share to non-OPEC nations if they aim for lower production levels and may be unable to recover it if – or when – the price rises. On the other hand, they will also lose out on market share and income to other (especially non-OPEC) producer states – if they try to keep the price any higher by restricting the production target. An international Hobson’s choice for OPEC members, it seems.

Commenting on this development, the New York Times noted, “The inability or unwillingness of OPEC to act showed that the cartel was no longer the dominating producer whose decisions determine global supplies and prices. Suddenly, the United States — which is poised to surpass Saudi Arabia as the world’s top producer, possibly in a matter of months — is in that position, although the resiliency of that new command must still be tested. ‘This is a historic turning point,’ said Daniel Yergin, the energy historian. ‘The defining force now in world oil today is the growth of U.S. production. The outcome of the OPEC meeting is a clear indication that the oil exporters now recognise that this is a new market.’ ”

The State Department’s coordinator for international energy affairs in Barack Obama’s first administration, David Goldwyn explained, “What we have now is a yearlong game of chicken. The Saudis are waiting to see how much U.S. production adjusts because of prices and they are waiting to see how much pain the other major oil producers can take before they are willing to make meaningful cuts.” He added that if the international benchmark price per barrel “sinks below $60, I think you will see OPEC hit the panic button pretty fast.” That development would almost certainly trigger an emergency OPEC meeting and some fast action to cut production – in the hopes such a decision would stabilise the price before it falls even further.

This is happening in large measure because the world is increasingly swimming in petroleum because of the oil shale and oil sands boom in North America, in addition to the continuing weak demand for the product. Moreover, non-OPEC nations like Russia have been trying to sell as much as possible of their energy commodities in that same, increasingly crowded buyers’ market. The fall in price, albeit a drastic, sudden one, should not really be a surprise as a result.

The other day, Citibank analysts noted global petroleum supplies now exceed demand by about some 700,000 barrels a day – no small potatoes in the crude oil world. As a result, the price for US crude hit $66.15 a barrel on Friday, a drop of 38% since June’s level of $107. Meanwhile, the price for international oil benchmark grade Brent crude had fallen to $70.15. Analysts now predict the bottom has not yet been reached, with the Oil Price Information Service (OPIS), for example, saying this price rout likely will continue for at least another $5/barrel drop – or maybe even $10.

So, if the price continues its slide, and consumers in many countries are virtually laughing all the way to the pump, exactly which nations are laughing or crying – and why? In the case of America, its economy will be gaining a real boost from the lower oil prices, in part because the country is still the world’s largest oil consumer. As a result, with the price falls going on, the per gallon (one gallon equals 3.78 litres) prices may drop by as much as a dollar per gallon from the peak price of $3.70 a gallon just six months earlier.

This windfall would equal a $60/month (roughly R700) net savings for the average household that is then available for other purposes. Contemplating this shift in spending and putting it into perspective, one OPIS analyst told the media, “It’s a nice easy, calculation. These are numbers that we would have regarded three or four months ago as something from the lunatic fringe.”

In offering the historical context of some of the reasons for this change, The New York Times explained, “For decades, the United States faced dwindling domestic production and rising demand, leading President George W. Bush to call on the country to get off its ‘addiction’ to imported oil. But around eight years ago a few small oil companies began experimenting to produce oil from hard shale rocks in North Dakota and Texas, using hydraulic fracturing — fracking — and horizontal drilling techniques that proved effective in producing natural gas a few years earlier.

“Domestic oil production has soared more 70 percent over the last six years, to roughly nine million barrels a day. The country is still a net importer, but with production growing by more than a million barrels a day every year, it is importing less and less almost every month. Imports from OPEC producers have been cut by more than a half in recent years, forcing increasing competition among Saudi Arabia and other exporting countries seeking to replace the American market with Chinese and other Asian markets. That has produced more cracks in an organisation in which competition between Saudi Arabia and Iran is already fierce.”

Michael Lynch, the president of Strategic Energy and Economic Research and a sometimes-consultant to OPEC, says, “OPEC still has power in that they can still cut production and raise price if they choose to do so. [But] They don’t have the same power they once did because so many of the members are in bad financial condition and so it’s harder for them to cut production and lose revenues in the short term to raise prices.”

Considering these developments, a recent Economist leader noted, “Today’s falling prices are caused by shifts in both supply and demand. The world’s slowing economy, and stalled recoveries in Europe and Japan, are reining back the demand for oil. But there has been a big supply shock, too… But a price cut of 25% for oil, if maintained, should mean that global GDP will be roughly 0.5% higher than it would be otherwise.”

However, some oil companies leading the production boom in the US and Canada may not be quite as pleased as their ultimate consumers. This is because the crude that comes out of those Canadian oil sands, the deep off-shore platforms anchored in the Gulf of Mexico, and those US oil shale reservoirs is among the world’s most expensive oil to lift out of the ground and send it on its way. As prices decline, some drillers will dial back on production so as to keep their expenses under control. Some have already argued that trying to force this slowdown in North America may have been part of OPEC’s own rationale for refusing to cut production among its members, even if their per barrel price remains low. (Middle East oil is especially inexpensive to lift from its underground reservoirs.)

However, it is also true, according to the New York Times, that “Even as prices slid in October, production in the Bakken shale field in North Dakota and the Eagle Ford field in Texas — the two primary promoters of the American oil production boom — increased more than three percent over the month before” because US producers continue to improve the efficiency of their production. Perversely, says the Times, “in the short run, lower prices can actually encourage companies to produce more to pay debts and dividends.”

The situation in Western Europe is a somewhat different case from that of the US. Because most of those nations are major net importers of oil, given the lower crude oil price, this is likely to give a modest boost to growth in the region. This should be particularly important for the eighteen nations of the Eurozone, many of which have high rates of unemployment. However, because this same price decline will keep inflation in check, perversely, it may make it harder for the Eurozone’s most troubled economies to reduce their debt levels, as debt isn’t devalued from rises in inflation. Among the handful of European nations that actually produce significant amounts of crude oil, the resulting drop in revenues might even largely offset the economic positives stemming from cheaper fuel, from an individual consumer’s point of view.

Moving east to Russia, the impacts for that nation are rather more troubling. Russia already gains around half of its state revenue from oil exports. As prices fall, the government’s revenue falls apace. The country is already sliding into a recession, and international investors have been withdrawing their funds in the face of the economic decline as well as the western sanctions that were triggered by Russia’s de facto annexation of Crimea. The resulting fall in revenue will not make things better.

Curiously, Russian consumers are not necessarily faring well from the drop in oil prices, unlike consumers in so many other nations. For Russian consumers, the outlook is more problematic. Prices at the fuel pump have actually gone up for them because the rouble’s devaluation has increased inflation in the country – and so there has been little if any savings benefit from the decline in the price of oil.

Meanwhile, in Venezuela, still one of the world’s leading oil producers, the government there clearly lost out at the OPEC meeting. It had been pushing strongly for a cut in OPEC production so as to help bolster prices so as to fund the Venezuelan government’s entire pattern of spending. More troublesome for that country’s government, oil production there has been declining for years. As a result, the combination of lower output and lower prices is pinching the nation’s finances. Paradoxically, because Venezuelan automobile drivers’ fuel needs are already so highly subsidised, they will gain little benefit from the price fall because they are only paying around $.05/gallon now.

Shifting to Japan, also a major net importer of oil, the price drop has been only slowly reaching consumers. Moreover, the recent drops in the yen’s value relative to the dollar (and it should be remembered that the international petroleum trade is denominated in dollars) will shrink any savings that Japanese consumers will gain from the lower oil price. However, as the price does fall and is eventually passed along to the consumer, this will complicate the Japanese government’s efforts to turn the economy’s ongoing deflation around.

Meanwhile, in China and some of the emerging market economies of Asia, circumstances vary as well. Since the Chinese government adjusts fuel prices in accord with global pricing, it has been cutting fuel costs repeatedly. A decline in prices can help add some buoyancy to an economy that has been slowing down in the recent past. And, of course, it will cut down on the bill for its importation of oil from sources in Africa and the Middle East.

Other countries, especially those with energy subsidy regimens have more problematic circumstances. As the Economist noted,  “Many other countries are also wrestling with energy subsidies. Indonesia spends about a fifth of its budget on them. Gulf oil exporters are even more profligate: Bahrain spends 12.5% of GDP and Kuwait, 9%. Brazil wants a high oil price to attract investment to its ultra-deep offshore (pré-sal) oil reserves…. Energy subsidies cost Egypt 6.5% of GDP in 2014, Jordan 4.5%, and Morocco and Tunisia 3-4%. A 20% fall in the oil price would improve the fiscal balances of Egypt and Jordan by almost 1% of GDP, says the IMF.”

The Economist ponders whether these efficiency gains will be sufficient to encourage shaky regimes to cut subsidies that mostly benefit the politically influential middle classes. For example, in Indonesia, the domestic price for petrol and related products has actually risen on the street as the government continues to cut subsidies – and street protests have followed. The newest fall in oil prices may help lower the political temperature in that nation. Meanwhile, Malaysia, as an oil-exporting nation, the drop in prices has hurt government revenues – but the government has also been cutting subsidies and that may help ease the pressure on the government’s budget.

Countries like Nigeria, South Sudan and Angola, all almost totally dependent on oil revenues (outside of any foreign aid flows), will find these continuing drops in oil prices will similarly confound budget planners as declining revenues mean less money will be available for all those big infrastructure projects on the planning tables. And various Middle East nations will find that – if they haven’t already – that their broad social welfare networks of spending for citizens is will be at risk as revenues drop from those earlier giddy levels of over a $100/barrel down – and down into the $60 range. All of these exporter countries could even see bigger threats of disorder as social spending is scaled back under the pressure of scarcer oil revenues.

Reuters’s commentator Ed Crosley noted, for example, that “Plunging world oil prices have dealt a blow to Africa far greater — purely in economic terms — than Ebola, setting back investment in exploration and plans to industrialise. The highest-profile victim so far has been Africa’s top producer, Nigeria, which was forced to devalue its currency 8% this week after the central bank admitted dwindling reserves were making it hard to defend it. In dollar terms, the devaluation knocked $40bn off the value of Nigeria’s economy — considerably more than the $32bn worst-case scenario the World Bank projected during last month for Ebola’s economic effect on the entire sub-Saharan region.”

For South Africa, however, economist Cees Bruggemans argues that this global slide in oil prices can offer real benefits, especially given the current weaknesses in the economy. As he wrote over the weekend, “The Brent oil price has now fallen by 40% in only five months, still topping $115 in late June and ending November by dipping below $70. That’s a drop of $45, worth how much to us? A whopping lot, as it turns out. South Africa uses some 750,000b/d of oil, split between domestic production (Sasol, Mossgas) of about 190,000b/d and 560,000b/d through the refineries. Overall, when allowing for extensive refinery down time (these old facilities require more maintenance) actual crude imported runs at about 190mb annually. Thus the amount ‘saved’ by the country from a $45 drop in crude oil prices comes to about $8.5bn in a full year. On a GDP of $350bn, that’s about 2.5% of GDP (compared to a current account deficit earlier in the year of about 6.5% of GDP annualised).” Of course militating against the full impact of the price cuts has been the slide of the rand against the dollar.

Despite this optimistic view, Bruggemans warns, “There is one more hurdle to take, in the person of the Minister of Finance. He must be sorely tempted to confiscate a very large portion of this gratuitous, serendipitous global oil windfall coming to us, courtesy of the American shale fracking revolution, backpedalling Chinese consumers and businesses, warlike Russians and others upsetting geopolitical apple-carts inviting retribution, and a Saudi oil swing producer prepared to take out global high-cost marginals for the long pull. If so, such SA budgetary upsets in February would merely be a different way of utilising the incoming windfall….” The temptations to keep some share of this windfall will surely tantalise a government already scrambling for every penny to keep up its plans for infrastructure building in a circumstance where a growing share of national budget expenditures are for personnel, rather than programmes.

Curiously, one issue that has not been spoken about much in the commentary on this decline in oil prices, so far at least, is the possible impact on the drive to develop and make use of alternative energy sources. At a $100 a barrel, the push is there for experimentation and more effort on conservation and alternative energy sources. A price like that encourages conversion of vehicle fleets to hybrids, hydrogen engines and electrics. By contrast, a 40% drop in cost may encourage users to rethink such shifts in the near and middle term future, to the detriment of the development of cost-effective alternatives. And this doesn’t even discuss the impact on climate as the use of hydrocarbon fuels marches right back up the scale, as they are increasingly inexpensive to use.

If in times gone by, the rising prices and scarcities of petrol caused civil disruption and even contributed to the demise of some political careers, the paradox is that in today’s circumstances, the collapse of prices will generate both gains and loses for consumers and governments alike – and it may well hinder efforts to build on conservation and energy efficiency. DM

Photo: A file picture dated 20 November 2003 shows the P-26 platform of Brazilian petroleum company Petobras, anchored 175 km from the shores of Rio de Janeiro, Brazil, where one hundred thousand oil barrels are extracted per day. According to reports on 13 November 2014, Petrobras reports the production of domestic crude oil has hit an all-time high of 2,126.4 Million Barrels per Day. EPA/MARCELO SAYAO

Read more:

  • Free Fall in Oil Price Underscores Shift Away From OPEC at the New York Times
  • Cees Bruggemans: Oil price collapse to boost SA economy at least 2.5% in 2015 at;
  • Oil plunge is threat and boon to global economies at the AP
  • Prise Commodity — Oil Prices Are Plunging. Here’s Who Wins and Who Loses and the New York Times
  • Oil Plummets After OPEC’s Decision in the New York Times (from Reuters)
  • A simple guide to the sudden collapse in oil prices at the Washington Post
  • Winners and losers America and its friends benefit from falling oil prices; its most strident critics don’t at the Economist;
  • Low oil price harms investment in Africa at Business Day

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