Cheaper oil- Many winners, a few bad losers

Cheaper oil- Many winners, a few bad losers

A lower price will boost the world economy and harm some unpleasant regimes—but there are risks

Crude oil prices -2014

Crude oil prices -2014

Oct 25th 2014 | The Economist magazine

THE collapse of the Soviet Union in 1991 had many causes. None was as basic as the fall in the price of oil, its main export, by two-thirds in real terms between 1980 and 1986. By the same token, the 14-year rule of Vladimir Putin, heir to what remained, has been bolstered by a threefold rise in the oil price.

Now the oil price is falling again. Since June, it has dropped from about $115 for a barrel of Brent crude to $85 or so—a reduction of roughly a quarter. If prices settle at today’s level, the bill for oil consumers will be about $1 trillion a year lower. That would be a shot in the arm for a stagnating world economy. It would also have big political consequences. For some governments it would be a rare opportunity; for others, a threat.

The scale of shale

Predicting oil prices is a mug’s game (we speak from experience). The fall of the past three months is partly the result of unexpected—and maybe short-lived—developments. Who would have guessed that chaotic, war-torn Libya would somehow be pumping 40% more oil at the end of September than it had just a month earlier? Saudi Arabia’s decision to boost output to protect its market share and hurt American shale producers and see off new developments in the Arctic was also a surprise. Perhaps the fall was exaggerated by hedge-fund investors dumping oil they had been holding in the false expectation of rising prices.

Geopolitical shocks can surprise on the upside as well as the down. Saudi Arabia may well decide to resume its self-appointed post as swing producer and cut output to push prices up once more. With war stalking Iraq, Libya still fragile and Nigeria prey to insurgency (see article), supply is vulnerable to chaotic forces.

But many of the causes of lower prices have staying power. The economic malaise weighing down on demand is not about to lift, despite the tonic of cheaper oil (see article). Conservation, spurred by high prices and green regulation, is more like a ratchet than a piece of elastic. The average new car consumes 25% less petrol per mile than ten years ago. Some observers think the rich world has reached “peak car”, and that motoring is in long-term decline. Even if they are wrong, and lower prices encourage people to drive more, energy-saving ideas will not suddenly be uninvented.

Much of the extra supply is baked in, too. Most oil investment takes years of planning and, after a certain point, cannot easily be turned off. The fracking revolution is also likely to rage on. Since the start of 2010 the United States, the main winner, has increased its output by more than 3m barrels per day to 8.5m b/d. Shale oil is relatively expensive, because it comes from many small, short-lived wells. Analysts claim that a third of wells lose money below $80 a barrel, so shale-oil production will adjust, helping put a floor under the price. But the floor will sag. Break-even points are falling. In past price squeezes, oilmen confounded the experts by finding unimagined savings. This time will be no different.

For governments in consuming countries the price fall offers some budgetary breathing-room. Fuel subsidies hog scandalous amounts of money in many developing countries—20% of public spending in Indonesia and 14% in India (including fertiliser and food). Lower prices give governments the opportunity to spend the money more productively or return it to the taxpayers. This week India led the way by announcing an end to diesel subsidies. Others should follow Narendra Modi’s lead.

The axis of diesel

For those governments that have used the windfall revenues from higher prices to run aggressive foreign policies, by contrast, things could get uncomfortable. The most vulnerable are Venezuela, Iran and Russia.

The first to crack could be Venezuela, home to the anti-American “Bolivarian revolution”, which the late Hugo Chávez tried to export around his region. Venezuela’s budget is based on oil at $120 a barrel. Even before the price fall it was struggling to pay its debts. Foreign-exchange reserves are dwindling, inflation is rampant and Venezuelans are enduring shortages of everyday goods such as flour and toilet paper.

Iran is also in a tricky position. It needs oil at about $140 a barrel to balance a profligate budget padded with the extravagant spending schemes of its former president, Mahmoud Ahmedinejad. Sanctions designed to curb its nuclear programme make it especially vulnerable. Some claim that Sunni Saudi Arabia is conspiring with America to use the oil price to put pressure on its Shia rival. Whatever the motivation, the falling price is certainly having that effect.

Compared with these two, Russia can bide its time. A falling currency means that the rouble value of oil sales has dropped less than its dollar value, cushioning tax revenues and limiting the budget deficit. The Kremlin can draw on money it has saved in reserve funds, though these are smaller than they were a few years ago and it had already budgeted to run them down. Russia can probably cope with today’s prices for 18 months to two years, but the money will eventually run out. Mr Putin’s military modernisation, which has absorbed 20% of public spending, looks like an extravagance. Sanctions are stifling the economy and making it hard to borrow. Poorer Russians will be less able to afford imported food and consumer goods. If the oil price stays where it is, it will foster discontent.

Democrats and liberals should welcome the curb the oil price imposes on countries like Iran, Venezuela and Russia. But there is also an increased risk of instability. Iran’s relatively outward-looking president, Hassan Rouhani, was elected to improve living standards. If the economy sinks, it could strengthen the hand of his hardline opponents. Similarly, a default in Venezuela could have dire consequences not just for Venezuelans but also for the Caribbean countries that have come to depend on Bolivarian aid. And Mr Putin, deprived of economic legitimacy, could well plunge deeper into the xenophobic nationalism that has fuelled his campaign in Ukraine. Cheaper oil is welcome, but it is not trouble-free.

Post a comment or leave a trackback: Trackback URL.

Comments

  • compton de castro  On October 25, 2014 at 7:49 am

    As oil prices fall so does value of USD.
    FRACKING also becomes ‘un-economic‘…. a win win situ
    for our planet. Lets hope ‘solar’ replaces fossil fuel as the energy source ?
    Solar energy is the future regardless of cost.
    My homestead in south Spain is 100% solar….even my hot
    water….no electric or gas bills. Initial cost 1500 euros…25 years guarantee ! Thats my energy bills paid for next 25 years.
    Nothing is impossible only improbable !
    Que sera sera
    What will Arabs and others do with their ‘black gold’ ?

  • Albert  On October 25, 2014 at 12:26 pm

    One reason oil price is falling is because the US is producing more. In 2015 only Saudi Arabia will be producing more oil than the US. We will be exporting more than we import. Lower energy (oil & gas) price is great for US consumers and economy. We can squeeze countries like Venezuela, Russia and Iran a bit more.

  • gigi  On October 26, 2014 at 12:00 pm

    This airy Economist piece is a major economic fail. It costs American oil producers $85/95(?) to produce a barrel of oil. This is not feasible when oil is selling for $85 a barrel. So where is this boon for America given its dire economic state of affairs and the added impact this will have on its oil economy?

    http://ourfiniteworld.com/2014/10/22/eight-pieces-of-our-oil-price-predicament/

    “Prices for new oil development have been too low for many oil producers for many months. The cutback in investment for new production has already started taking place, as described in my post, Beginning of the End? Oil Companies Cut Back on Spending. It is quite possible that we are now reaching “peak oil,” but from a different direction than most had expected–from a situation where oil prices are too low for producers, rather than being (vastly) too high for consumers.

    The lack of investment that is already occurring is buried deeply within the financial statements of individual companies, so most people are not aware of it. Dividends remain high to confuse the situation. By the time oil supply starts dropping, the situation may be badly out of hand and largely unfixable because of damage to the economy.”

    Low oil prices: Sign of a debt bubble collapse, leading to the end of oil supply?

    Oil and other commodity prices have recently been dropping. Is this good news, or bad?

    I would argue that falling commodity prices are bad news. It likely means that the debt bubble which has been holding up the world economy for a very long time–since World War II, at least–is failing to expand sufficiently. If the debt bubble collapses, we will be in huge difficulty.

    http://ourfiniteworld.com/2014/09/21/low-oil-prices-sign-of-a-debt-bubble-collapse-leading-to-the-end-of-oil-supply/

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: