Oil prices are tumbling. The price of Brent, the benchmark for oil prices in Europe, fell by some 40 per cent since June 2014, and is now hovering around the $70 a barrel mark.
Meeting in Vienna last month, Opec decided not to cut back on its oil production. The decision marked a change in tactics by Opec; the cartel is evidently more interested in defending market share than in ensuring the best price for its oil. Gone are the days when Opec controlled the supply of oil to the world. Producing 30 million barrels a day, its share of the global market has shrunk to just 40 per cent.
This was no easy decision for Opec. Many of its members wanted to raise prices, as they need it to be at least $120 a barrel to balance their budgets. Saudi Arabia, once again, had the final say. Having the second largest oil reserves (estimated to be 267 billion barrels) and an average production cost of less than $20 a barrel, Saudi Arabia is the sole ‘real’ power behind Opec.
Why are oil prices plummeting?
There are some purely economic reasons relating to the supply and demand of crude oil. Despite sanctions on Iran, the almost complete shutdown of production in Libya and lower production in Iraq and Syria (due to internal strife and the war against the Islamic State) there is an excess in global oil supply of about two million barrels a day.
A significant part of this oversupply is due to the USA increasing its oil production from 5.7 million to 8.4 million barrels a day in just three years. The USA is expected to become the world’s largest producer of oil by 2020. A significant part of this oil is obtained through ‘fracking’, which involves pumping chemicals, sand and water at high pressure underground to fracture shale rock and release the oil. The cost of producing this shale oil in the USA varies from $40 to $111 a barrel and Opec’s decision could be meant to force a number of operators out of business.
Savings from falling oil prices should lead to higher disposable incomes for households and lower operating costs for businesses
Another consideration relates to the slowdown in global economic growth. Europe, China and Japan continue to stagger and their poor economic performance impacts negatively on the demand for oil. Significant economic growth in China had been pushing oil prices upwards and the emerging Asian power is now the second largest oil-consuming nation after the USA. China presently has the lowest economic growth rate in the last five years.
Oil importing economies (including Malta, of course) welcome falling prices as this represents a lower drain of foreign exchange. It is estimated that, at $85 a barrel, these economies will save about $1 trillion in their import bill. These savings should lead to higher disposable incomes for their households and lower operating costs for their businesses. This should, in turn, stimulate demand and drive higher economic growth.
Also, the dynamics of energy markets are changing fast. Global power generation is no longer dependent on the price of diesel and fuel oil. These fossil fuels accounted for 25 per cent and five per cent of power generation in 1973 and 2014 respectively.
Historically, falling oil prices have impacted negatively on renewables but the two now hardly mix at all. Investment in renewables is driven by long-term considerations and shorter-term fluctuations in oil prices have little effect. Indeed, the cost of investment in renewables itself has fallen by 80 per cent over the last five years.
Many analysts, however, believe that there are also non-economic factors leading to the fall in oil prices. History keeps repeating itself, as oil is once again being used as a political weapon. The fall in oil prices is being seen as part of a Saudi-American plan to undermine ‘rogue’ states.
Russia is probably the main target following its interference in the Ukraine. Economic sanctions are already hitting Russia hard and the value of the rouble has practically halved in the last few months. The international debt of Russian corporations exceeds $600 billion. The high cost of servicing this debt is already crippling a number of them and lower revenues from oil could send them into bankruptcy.
Iran is another possible target. The country has been facing sanctions since 1979 and these have been extended due to its uranium enrichment programme. Falling oil prices are bound to impact negatively on the country’s generous social welfare system. It is estimated that the Islamic Republic needs a price of $140 a barrel to balance its Budget.
There are also growing allegations that the price of oil over the last decade has been rigged by some of the world’s biggest oil companies and energy traders. Last May, EU anti-trust authorities raided the offices of BP, Shell and Platts (an energy news and price publisher whose quotes serve as a benchmark for traders around the world). Last month, four established oil traders opened a lawsuit in the USA making similar allegations involving, among others, Morgan Stanley and the Vitol Group.
The outlook for oil prices is bleak. Goldman Sachs has slashed the price forecast to $70 in 2015 and $80 in 2016. Other traders insist that the price will have to go down to $60 a barrel before stabilising at the $80 mark.
Understanding the geo-economics of oil prices is a formidable task. At this stage, nobody really knows where the bottom is or how long it will take for oil prices to start bouncing back.
fms18@onvol.net