Alwaght-The price of oil has fallen by nearly half in just six months because global supplies are increasing at a time when a weak global economy is slowing the oil demand growth. This is a surprising and steep plunge that has consumers cheering, producers howling and economists wringing their hands over whether this is a good or bad thing.
The world oil price has fallen by more than 50% since June, when it was $115 a barrel. It is now below $54. US oil prices slipped below $50 a barrel for the first time since 2009.This comes after nearly five years of stability.
OPEC, which pumps out about 40 percent of the world’s oil, has so far refrained from cutting its production to balance the market mainly. This was due to opposition from Saudi Arabia at a meeting in Vienna on November 27th.
So, why exactly is the price of oil falling?
The oil price is partly determined by actual supply and demand, and partly by expectation. Demand for energy is closely related to economic activity. It also spikes in the winter in the northern hemisphere, and during summers in countries which use air conditioning. Supply can be affected by weather (which prevents tankers loading) and by geopolitical upsets. If producers think the price is staying high, they invest, which after a lag boosts supply. Similarly, low prices lead to an investment drought. OPEC’s decisions shape expectations: if it curbs supply sharply, it can send prices spiking. Saudi Arabia produces nearly 10m barrels a day—a third of the OPEC total.
Several things are now affecting the picture. Demand is low because of weak economic activity, increased machine efficiency needing less fuel to function, and a growing switch away from oil to other fuels. Second, turmoil in Iraq and Libya—two big oil producers with nearly 4m barrels a day combined—has not affected their output. The market is more sanguine about geopolitical risk. Thirdly, America has become one of the world’s largest oil producers. Though it does not export crude oil, it now imports much less, creating a lot of spare supply. Finally, the Saudis and their Persian Gulf allies have decided not to sacrifice their own market share to restore the price. They could curb production sharply, but the main benefits would go to countries they detest such as Iran and Russia. Saudi Arabia claims it can tolerate lower oil prices quite easily.
There have been also numerous reports about the discord between OPEC members, leading many to believe that OPEC will not be able to reign in production like it has done so in the past. The Saudis and Kuwaitis have reportedly been in an oil price war, repeatedly lowering their prices in order to maintain their market share in Asia.
Oil supplies have gone boom while world demand remains tepid.
The economies of China, Japan and western Europe – the top oil consumers after the US – all appear to be weakening. Oil demand falls when economic growth stalls.
Opec estimated that the world would need 28.9m barrels of its oil per day this year, the lowest in more than a decade. At the same time, Opec countries plan to produce 30m barrels of oil per day this year.
Russia's 2014 oil output hit a post-Soviet record high average of 10.58 million barrels per day.
That supply surplus is sending global prices lower.
So who is benefitting and who is definitely not?
For drivers, shippers, airlines, other consumers of fuel, and especially for oil-importing countries, there’s nothing not to like about the drop in oil prices.
But the main negative impact is on the riskiest and most vulnerable bits of the oil industry. These include American frackers who have borrowed heavily on the expectation of continuing high prices. They also include Western oil companies with high-cost projects involving drilling in deep water or in the Arctic, or dealing with maturing and increasingly expensive fields such as the North Sea.
Lower oil prices mainly present a major economic risk to oil-producing nations like Russia, Saudi Arabia, Iran, Iraq Venezuela and Nigeria.
Also in the US, where some states rely on taxes from energy production such as Alaska, North Dakota, Oklahoma and Texas, they will see lower revenues and some have already had to trim budgets.
While oil price is crashing it is taking down some stocks with it, affecting US energy stocks, the Russian rouble, junk-bond prices, and portfolios.
The Oil War
“It was heinous. It was underhanded. It was beyond the bounds of international morality. It was an attack on the American way of life. It was what you might expect from unscrupulous Arabs. It was “the oil weapon” -- and back in 1973, it was directed at the US. Skip ahead four decades and it’s smart, it’s effective, and it’s the American way. The Obama administration has appropriated it as a major tool of foreign policy, a new way to go to war with nations it considers hostile without relying on planes, missiles, and troops. It is, of course, that very same oil weapon.” says a Western analyst.
Today, Saudi Arabia is once again using its "oil weapon", but instead of driving up prices and cutting supply, it's doing the reverse. Saudi Arabia, the biggest exporter in the world, has reinforced the sharp decline in oil prices by increasing oil production as well as cutting prices to some markets.
In the face of a global slide in oil prices since June, the Saudis have refused to cut its production, which would help to drive prices back up. Instead, the Saudis led the charge to prevent OPEC from cutting production at the cartel's last meeting on Nov 27.
Saudi Arabia, a lackluster global economic growth, has two targets in its latest oil war: it is trying to wipe U.S. shale oil—which requires higher prices to remain competitive with conventional production—out of the market. More broadly, the Saudis are also trying to put some pressure on its two rivals, Russia and Iran, because of their support for Syria.
Since the U.S. invasion of Iraq in 2003, Saudi Arabia has been nervous about the growing influence of Iran: its nuclear ambitions, its sway over the Iraqi government, its support for Hezbollah and Hamas, and its alliance with Syria.
Still, Saudi Arabia, which oil exports make up about 90 percent of its income, is playing a dangerous game—there is little evidence that Russia and Iran would change their behavior under economic pressure. Worse, the Saudi policy could backfire, making Russia and especially Iran stronger in countering Saudi influence in the Middle East. Also under pressure Russia and Iran may find a solution like Iran’s attempt to shift from a current oil-based economy to a science-based one.
As a matter of fact Iran expects to slash its dependency on oil revenues to all-time lows.
Iran’s vice-president for scientific and technological affairs announced that oil dependency in the new draft budget proposed for the next Iranian calendar year (which starts on March 21) would be around 30 percent.
A censure from the inside
The strongest criticism to the Saudi’s stubborn economic policy comes from within the royal family Prince Alwaleed bin Talal. He has severely criticized Saudi Arabia’s fiscal policy following Riyadh’s announcement of the 2015 budget with the largest-ever deficit following sharp slump in oil prices.
“We have reached the danger point...after starting to withdraw from the reserves to meet the budget deficit,” said Saudi billionaire Prince Alwaleed bin Talal in a letter addressed to Saudi Finance Minister Ibrahim bin Abdulaziz Al-Assaf.
In late December 2014, Saudi Arabia unveiled its 2015 budget, saying it was “rationalizing” its expenditure without specifying any details. The budget has a huge USD 38.6-billion deficit.
The Saudi tycoon, who is a member of the ruling family and the wealthiest Arab private investor, also said they should not have let spending rise above revenue in the wake of falling oil prices.
The Saudi prince’s criticism comes as latest global oil market data showed that the prices continued their downward trend near closing time.
Iran has criticized Saudi Arabia for its lack of cooperation in preventing the fall in oil prices. Riyadh has said that OPEC will not cut oil production even if oil prices fall to USD 20 a barrel
Investors bet on further lower prices
Some analysts are eyeballing on lower oil prices in 2015, something around 40 dollars a barrel.
Iranian Petroleum Minister Bijan Nambar Zangeneh said that the future of oil prices is “not predictable,” adding, however, that “political factors and intentions” could have a negative impact on global oil sales.
“Political factors and intentions are affecting the prices [of oil], and of course we could offer estimates on this issue,” said Zangeneh.
So what is the solution?
Some worried economists say the depth of oil’s plunge could be a signal that the global economy is struggling even more than economists think. But the solution is attainable by cutting down on oil production in order to bring down supplies, which eventually causes the requested rebound in oil prices. This decision must be taken by Opec, Saudis in specific, and also non-Opec countries, such as Russia.
Saudis must sincerely think of their sensitive situation concerning the expected death of their king Abdullah bin Abdul-Aziz, where analysts suspect a turmoil of succession in the royal family. The Saudi’s king death will also bring down their market as presumed, since the Saudi market already went down 5% when Abdullah was hospitalized.
Even if experts do not see such a decision coming up soon and no rebound in oil prices in speculated, a serious action must be taken by the main oil-producing countries such as Saudi Arabia, US, and Russia.
