Introduction
A fluctuation in the world oil market manifests itself on nations in a myriad of ways; an increase in the price leads to inflation in the oil-importing nations, whereas the oil exporters laugh all the way to the banks; the reverse occurs when oil prices drop! Since 2014, oil price have been moving southwards; continuing the rapid tumble that began in June of that year, oil price hit its lowest level since the summer of 2004, in early January of last year. The global benchmark, Brent crude oil, traded at $33.37 per barrel in the first week of 2016, closing out the lowest week of prices in more than a decade.
A number of factors contribute to the fluctuations,mainly being economics and geo-politics. The historic high-band, which started around 2003, reflected the persistent long-term growth of China and India, the key oil-import economies. This price surge was briefly interrupted in the immediate aftermath of the global negative economic conditions. Regional contingencies like wars and civil strife also influence oil prices. There is also the effect of deliberate policy influence, notably by OPEC members, which produce 40% of the world’s oil supply with very low production costs.Since the OPEC crisis of the 1970s, the key producer, Saudi Arabia, has used its surplus capacity to influence price. The OPEC cartel is, however, at times, inept, given that some member nations tend to exceed their authorised production quotas.
Losers and Gainers
The steep dive in oil price sent tremors through the global political and economic order, setting off an abrupt shift in fortunes that bolstered the interests of USA, while pushingseveral big oil-exporting nations, particularly those hostile to USA, like Russia, Iran, and Venezuela, to the brink of an unprecedented financial crisis. The price plunge also influenced, to a certain degree, Iran’s deliberations with the P-5+1 nations, on its nuclear programme, which culminated in the treaty being signed on 14 July 2015; it brought about an easing of sanctions against Iran, which then entered the world oil market in a big way. The price drop, however, did unsettle the benefits of the lifting of sanctions.
Russia and Venezuela, on the other hand, were hit hard. Russia expected to weather the effects of sanctions imposed on it on the annexation of Crimea and its continued support tothe Ukraine separatists, by the revenue through its oil exports, which accounts for more than half of its budget, but it was not to be since its budget is calibrated to a much higher figurethan the market rate. A cut in its budget, however, was a difficult challenge for Russia, it being embroiled in a standoff with USA and its allies in Syria, and the IS, also in the same area.
An associated casualty of the price collapse was Belarus, a former Soviet territory, now a close ally of Russia, and long abhorred by USA as Europe’s last dictatorship. While it produces no significant amount of crude oil itself, Belarus’economy, nonetheless, took a big hit, being heavily dependenton the export of petroleum products that it produces using crude oil supplied, at a steep discount, by Russia.
Venezuela, another antagonist of USA, and a member of OPEC, has the world’s largest estimated oil reserves. It has used oil to position itself as a counter to American ‘imperialism’ in South America, and received 95 percent of its export earnings from petroleum before the price crash. On the fall of oil price, Venezuela started having problems paying for social projects at home and for an oil-financed foreign policy that included shipments of oil at concessional rates to Cuba and elsewhere, leading to a worry, at one time, that the country may default on its loans.
The only major antagonist of USA, not hurt by the drop in prices has been North Korea, since it imports all of its petroleum requirements. An indirect consequence of the slump in the price, as some analysts feel, has been the breaking of the five-decade old diplomatic logjam between Cuba and USA. Cuba, fearful that Venezuela, its main benefactor, might cut off supplies of cash and cheap oil, sealed a historic deal that, in turn, placed USA on a higherstanding in much of Latin America.
The Middle East and North Africa contain the greatest concentration of oil-dependent and oil-producing economies in the world. The region accounts for nearly a third of seaborne crude oil and liquefied natural gas exports. The Middle East, specifically the Persian Gulf, also home to the majority of OPEC production and exports. The Middle East, hence, is the region that is most exposed to volatility in global energy markets, while also being the region that can cause the most variation in global prices.
Many of the region’s key producers, Saudi Arabia, Kuwait, the United Arab Emirates, Libya, and Algeria, have hundreds of billions of dollars in currency reserves, due to years of artificially hiked prices of oil, thus insulated from short-term fluctuations in prices. Saudi Arabia, the United Arab Emirates and Kuwait combined have more than $2 trillion in their primary sovereign wealth funds alone. Others in the region are not as fortunate; due to domestic problems and high spending, Iraq has been left ravaged by war, whileIran has been hampered by sanctions, thus, both needing higher oil prices of more than $100 per barrel to balance their budgets. All these governments, feeling pressure from the ISand other regional conflicts and competitiveness, are showing signs of suffering with oil price continuing to remain low.
The downward pressure on the oil market is not solely from the supply side; recent regional developments are part of the current restructuring of oil price. The resumption of production in Libya, increased output in southern Iraq, the re-entry of Iran to the world markets, and stable production out of the other Gulf countries have had a cumulative effect on an oversupply of nearly one million barrels relative to demand.To overcome the difficulties, the OPEC and other major oil producing nations have initiated steps to curtail production, the effects of which have resulted in a marginal increase in the oil prices.
While oil producers like Russia and Venezuela wereclearly suffering, China was enjoying a huge windfall thanks to the price drop. Nearly 60 percent of the oil that China needs to power its economy is imported. China had become the world’s largest importer of oil in 2013, surpassing USA, and hence, stood to benefit from the southward prices. Bank of America, Merrill Lynch put forth an estimate in December 2014 that every 10 percent decline in the price of oil could increase China’s economic growth by 0.15 percent. Today, however, the Chinese economy is not showing the same rates of growth as compared to 2014, due to poor exports, and the decline of its housing market and related industries, which areat the heart of China’s economic slowdown, and thus, in large part determine China’s overall economic health. A collapse in the housing market, though unlikely, can send the Chinese economy into a tailspin, which, in turn, would then dampen its demand for oil. Notwithstanding, analysts feel that China’s demand for oil would remain relatively strong in the absence of an economic collapse, but China’s increases in demand are likely to be more moderate than usual, at an estimated 400,000 bpd over the course of the year.
Anything that helps revitalize consumer spending is a boon to the Japanese administration in Japan. Given Japan’s near-total reliance on crude oil and natural gas imports, a drop in the price of both, is good for its consumers and for the government’s feeble efforts to reverse what has become a chronic and, in recent months, worsening trade deficit. However, lower oil prices are not wholly good news for Japan. While they do bring down industrial input costs and, as a result, consumer goods prices, they simultaneously make it harder for the Bank of Japan to achieve its 2 percent inflation goal!
In the past decade, South East Asia’s rapid economic growth and increasing energy consumption has led to more reliance on oil imports, exposing the region’s economies to high financial costs and external fluctuations. A sustained period of lower oil prices should provide a cushion for most countries in the region, depending on their economic structure and energy consumption patterns.
Despite being one of the world’s three predominant oil producers, along with Russia and Saudi Arabia, USA is an oil-consuming leviathan, which means that low oil prices are undoubtedly a benefit for its economy. The American oil and gas revolution that caused its oil production to increase from 5.5 million barrels per day (mbpd) in mid-2011, to nearly 9 mbpd is adding to the overall health of the economy. Low oil prices, however, could undermine some of the benefits USAenjoys, relative to the rest of the world, but as of now, it has the best of both worlds, namely, falling energy costs that remain lower than the competitors’ costs and an increasingdomestic energy production. Analysts and business mogulsare in discussion on what should be the average break-even cost for shale oil production, particularly since it varies considerably from basin to basin, to decide its oil strategy, which would, in turn dictate the global price. Trade policies of Donald Trump, the new President of USA, would also become a topic for debate and could further affect the world oil prices.
Having considered all aspects, US shale production costs, as they stand today, have fallen dramatically over the last few years and are expected to maintain present levels, or even continue falling, especially if a surplus develops in adjuvant markets and production efficiency continues to rise. Regardless, at the current price of oil, the United States is at a point where energy prices are above the break-even point for domestic production, but low enough to benefit domestic consumers. For an industrialized economy where the backbone remains industry, services and manufacturing, this is an ideal situation.
India is currently the world’s fourth-largest energy consumer, trailing only China, USA, and Russia. It uses about870 million tons of oil and other products per year; a figure that has nearly doubled since 2000, with a scope to grow even further, considering the country accounts for 18 percent of the global population but just 6 percent of worldwide energy use. India, as per forecasts, would be the largest consumer in the world over the next 25 years. Currently, however, the 753,000 barrels per day that India produces, barely make a dent in the 3.7 mbpd that it consumes.
India’s rapacious appetite for energy is being fuelled by industrialization, robust growth, and urbanization, all of which are generally good news for the country’s economy, which overtook China’s as the fastest growing after expanding by 7.5 percent in 2015. Nevertheless, the country’s fast-growing economy, with its young, urbanizing population will place tremendous stress on its inadequate energy infrastructure as demand for energy resources continues to rise. Blackouts that swept across Northern India in July 2012, plunging some 700 million people into darkness amid the sweltering summer heat, are still fresh in people’s memory. The massive shutdown, which constituted the largest power outage in global reminiscence, paralyzed the country’s trains, halted traffic, and tarnished India’s image as a rising power on the international stage. Though the Government was able to restore power within 24 hours, the blackouts became a symbol of a much broader concern, viz, energy security. If India cannot secure an accessible and affordable energy supply for itself, its bright prospects for the future may grow dim.
Perhaps the most obvious and immediate problem is that India’s domestic oil production, at least at the moment, is insufficient. As previously mentioned, the country’s daily oil consumption far outweighs its output. Estimates indicate thatIndia holds about 5.7 billion barrels of oil reserves, of which some 56 percent are located offshore, where drilling is more difficult and costly than onshore. Indian oil output has not grown by more than two per cent at any point in the past two decades; 2016, the year just gone by, has not been much different, with the future too, not holding promise for foreign investments in the energy sector until India improves its image in the world rankings of ease in doing business.
Price is important for consumers like India, just as it is significant for other nations. Thus far, the low oil prices have brought cheer to the Indian economy by lowering inflation and its current account deficit. Conversely, lower prices often lead to higher demand, making India even more reliant on imported oil to meet its needs, putting the Indian economy at risk of collapse if global oil prices suddenly rise. Such circumstances damaged the Indian economy in 1991, when an unexpected surge in global oil prices after the first Persian Gulf War caused the country’s oil bill to zoom, and its foreign exchange reserves to plummet, forcing the Indian Governmentto seek an emergency loan from the International Monetary Fund.
Having learnt its lesson, India, since then, is buying equity stakes in oil and natural gas fields elsewhere; its rationale being that in the event of a price-rise, it can offset the higher costs by collecting revenues from the sale of oil and natural gas produced by its overseas assets. Another course of action that of economic reforms, however, is moving at a snail’s pace due to the unwieldy political and bureaucratic system, thus hampering the transition towards cleaner energy generation, and reducing dependence on fossil fuel. As India seeks to join the ranks of great powers in the 21st century, energy will play a critical role in its ascent; it, therefore, has to take quick measures to reduce its dependence on oil.
Conclusion
If the oil producers’ most recent attempt to coordinate a freeze in production is any indication, mustering the political will for one now, will be difficult. Talks on an agreement between OPEC and non-OPEC members to freeze production fell apart in several meetings through 2016, when Saudi Arabia insisted that Iran enter the agreement. Iran resisted, instead insisting that it would raise its output until it reachedthe levels it enjoyed prior to sanctions imposed by the West.
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Production freezes are one tool to raise oil prices during prolonged crises. The idea is that if all producers agree to cap their output at their current levels, when prices rise, none should move to capture the market share at the expense of the others; executing and enforcing such an agreement has not been easy. The market recovery, after the agreement signed in late 2016, has raised the oil price, which is now hovering around $ 55 per barrel; further recovery may continue, but the rise is likely to be painful and slow, with OPEC having little power to accelerate.
Saudi Arabia, in the recently concluded World Economic Forum at Davos, in Switzerland, has indicated that another freeze in production could not be ruled out “if higher prices don’t stick because of variables outside producers’ control, such as a potential collapse in demand”; the reduction in demand could be due to any reason, geo-political or economic.
Oil supplies form the backbone of modern industrial economies, and energy resources are critical export commodities for those who possess them in abundance. As long as fossil fuels remain the dominant source of energy, a scenario something that is likely to last at least another few decades, oil supply and oil prices will remain critical, leading to many gainers and losers.
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