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Since June, the price of oil has plunged 40% on the international market in response to economic slowdowns in Europe and Asia and a glut of supply from the Middle East and North America. The falling price of oil, near $60 a barrel at the time of the writing of this brief, has been a boon for nations that import fossil fuels. It also provides much needed stimulus for consumer-driven economies such as the United States as people are able to take the money they would normally spend on high gas prices and direct it to other economic activities. However, the falling oil price has worked against some economies that rely largely on the proceeds from oil exports. Countries such as Venezuela, Russia, and Nigeria, among others, are now left wondering how they will react to the sudden fall of global oil prices and the decisions that they make could determine whether their current governments survive.
This topic brief will cover the reasons for the collapse of global oil prices, how the falling price will affect the United States economy, and how prominent oil exporters will be affected.
Readers are also encouraged to use the links below and in the related R&D to bolster their files about this topic.
The Low Price of Oil
Following the global oil price, in addition to other economic indicators such as the American unemployment rate, its GDP growth rate, its inflation rate, and its interest rate, is something that all extempers need to do because of oil’s prominent role in economies across the world. Countries that export oil benefit from a high oil price as it funnels more money into the coffers of those economies (and by proxy their governments), while the countries that import large quantities of oil such as Japan or that have consumer-driven economies such as the United States and Western Europe are hurt by high oil prices as consumers see the price of gasoline, food products, airline tickets, and other products rise. This zaps money away from other economic activity or causes consumers to spend less. For example, high gas prices may cause fewer people to travel long distances on summer vacations, thereby harming tourist venues.
The Economist on December 6 notes that the global price of oil has been falling since June, when the price per barrel was pegged at $115. The price is now 40% less than that rate, hovering between $60 and $70 at the time of this brief and analysts expect prices to fall further. The Huffington Post on December 11 reveals that the some are saying oil could go as low as $55 a barrel, but others say that prices could continue to fall below that floor, possibly as low as $30. To put this into context, according to Slate on December 11, oil has not been below $60 a barrel since July 2009. The 2008 financial crisis weakened demand expectations for Western economies, so it was not alarming to see oil prices fall. This is why gasoline sold in some markets in late 2008 at less than $2 a gallon. When demand revived, global oil prices went back to $100 per barrel and that made oil exporting countries very happy. Extempers should keep in mind that these low oil prices may exist for a while, as The Wall Street Journal writes on December 11 that prices by the end of the month are likely to average $64.73 per barrel and then climb to $72.10 at the end of next year. This could change based on new economic circumstances or violence in oil exporting areas, but current projections show oil staying below the $100 per barrel threshold for the next twelve months.
The reason for the recent decline in global oil prices is because the demand for oil is well below supply. Economic theory holds that the more in demand a good is the higher the price will be in order to match the number of buyers with the number of goods suppliers are willing to offer. When a good is not in demand the price will fall to make it more attractive for new buyers, who may not be able to acquire the good at a higher price. Sagging global demand for oil is due in part to Europe’s economic difficulties and China’s economic slowdown. The European Central Bank (ECB) is desperately trying to find ways to rejuvenate the continent’s economy, which is grinding to a halt due to the austerity (budget cutting) policies of multiple governments. Unemployment also remains a big problem in European countries such as France and Spain. As Western nations sagged during the 2008 financial crisis, China was one of the few countries in the world maintaining global demand, especially in the commodities market as it pursued large-scale infrastructure projects. Foreign Policy on December 10 writes that the Chinese government has been transitioning toward a consumption-based economic model, which calls for less infrastructure spending and fewer exports (since the goal is for Chinese citizens to buy more products at home instead of manufacturing goods and shipping them abroad). As a result of this change, China has been consuming fewer commodities such as oil and that slack in demand is causing the price of oil to fall.
Another reason for the declining global oil price, as Market Watch documents on December 12, is that the world has very little to be worried about in the near term. Over the last few years fears of disrupted oil production due to the Arab Spring, a potential American bombing campaign against Syria, the potential collapse of the Iraqi government, and violence in the Ukraine have caused the price of oil to increase because markets feared supplies could be disrupted. However, oil continues to flow from Iraqi markets, largely because a bulk of its supplies are located in the Shi’ite South, which remains stable. Violence continues in Ukraine and Syria, but markets have not seen oil supplies as negatively affected as expected (markets tend to exaggerate the impact of disruptions because they would rather be safe than sorry), so those are no longer immediate concerns. The Wall Street Journal adds on December 1 that Iraqi and Libyan oil output has actually been increasing despite violence in both nations, so that has served to allay market anxieties as well. Of course, all it takes is a major terrorist attack, a significant offensive by the Islamic State against the Iraqi government, or some other major geopolitical fear to send oil prices back toward the sky, but as of right now those appear absent, thereby helping in the decline of oil on world markets.
When one thinks of the supply side of the global oil market their eyes are directed at the Oil and Petroleum Exporting Countries (OPEC). Established in September 1960, OPEC is a collection of twelve oil exporting nations in the Middle East, Africa, and Latin America. It acts as a cartel, using its 30% share of the world’s oil market to direct prices by increasing or decreasing the supply of crude oil that it is willing to release on the market. The cartel is dominated by Saudi Arabia, who possesses the second-largest claimed oil reserves in the world, and is an interesting organization in the sense that it brings regional rivals such as the Saudis and Iranians together. Near the end of last month, as the price of oil kept falling, the international media expected to see OPEC announce a production cut in order to stop the slide in oil prices and send them climbing again. However, that did not take place. Bloomberg on December 10 writes that at its November 27 meeting, OPEC announced that it would not reduce its thirty million barrel per day production target despite expecting global demand to fall in 2015. The announcement saw prices plunge another 17%. With OPEC refusing to cut production, prices are expected to remain low because a significant global actor is refusing to intervene to stop the slide.
Part of the reason OPEC might be refusing to cut the supply of oil is to drive the Western shale oil industry out of business. The Economist article from December 6 that was cited earlier notes that North Dakota, Texas, Pennsylvania, and other states have seen an economic boom from shale, with 20,000 new shale oil wells having been created since 2010. Shale oil has helped the United States increase its overall oil production by 33% and has put the country behind only Saudi Arabia in terms of daily output. The use of fracking, where water, sand, and chemicals are injected into shale formations to release oil, has been at the core of this relatively young industry and has contributed to rising global oil output. The Guardian on December 6 writes that since the shale industry requires oil prices to be near $70 or higher to be profitable, OPEC may be trying to force prices down to drive the industry into bankruptcy and, failing that, force the delay or cancellation of future projects. OPEC instituted a similar strategy in the 1980s and it worked, as investors were skittish about putting more funds in new projects due to a sudden downturn in the global oil price.
The Impact of Low Oil Prices on the U.S. Economy
American consumers are the big winners of low oil prices as lower gasoline prices will serve as a private market stimulus for economic growth. The Huffington Post article previously cited explains that the average nationwide price of a gallon of gasoline has fallen to $2.61, sixty-four cents lower than last year. The Department of Energy estimates that low gas prices will help American drivers save up to $7 billion a month and that the average American household will save $550 over the next year due to the low prices. Compared with the 2009 stimulus package, low gas prices are currently generating their own $1 trillion stimulus package for the economy. This is great during the holiday season and is also good for the economy in general as two-thirds of the U.S. economy is composed of consumer spending. All speeches that discuss low gas prices and the economy need to include this information. The second and third quarters saw excellent GDP growth and unemployment stayed below 6% last month (the rate is currently 5.8%). President Obama is probably incensed that low gas prices did not acquire notice until after the midterm elections, but the economic stimulus they provide may position Democrats to win the White House in 2016. Although the American president has very little direct impact on oil prices, many American voters think that they do, so presidents always welcome low gas prices.
What is good for consumers may not always be good for the oil business, though, which serves to be hurt by low prices. The Christian Science Monitor writes on December 10 that despite oil prices falling, oil companies are drilling at the highest rate in more than thirty years. This may be a sign that U.S. producers still see profits in a market where global demand is down because they think they can still win more market share. Quartz on December 11 notes that in the 1980s when Great Britain began exploiting the oil resources of the North Sea and when American oil entrepreneurs opened new wells to reduce OPEC’s hold on the world market, they found new markets for their oil resources because they offered them at a lower price than OPEC. This eventually forced OPEC to cut prices to undercut its competitors. For example, Saudi Arabia can bear a low production price for oil at $5-$6 per barrel, and by cutting prices it bled its Western competitors, forced several into bankruptcy, and chilled investment in the oil sector, thereby eventually profiting when oil prices rose because of declining global supply over the next decade. CNN on December 10 writes that OPEC sees Western competitors gaining more market share, but it is still confident that it can play a long-term game of winning a war of attrition. Customers may appreciate lower prices, but the low prices may eventually drive some wells under, thereby causing unemployment in the energy sector, which Quartz notes has been the one sizable area of job growth since the financial crisis. The number of oil and natural gas jobs has increased by 35% in the United States since 2008, while growth in other sectors only rose 7% combined. If the oil industry ends up crippled by low oil prices or has to put off new projects, unemployment rates could end up increasing.
An area extempers should monitor and expect to receive questions on over the next year is the shale oil industry and how it may survive low prices. The shale industry operates on very thin margins. The Economist previously cited from December 6 explains that before oil prices declined new wells were being built despite the companies constructing them not yet earning sizable profits on their previous wells. In other words, companies are expanding operations on the hope of generating profits rather than realizing profits first and then expanding. The Economist warns that next year might be littered with the bankruptcies of shale oil firms, which could make investors nervous about throwing more dollars into new shale oil ventures. Already, shale oil firms are seeing their stocks prices fall, which is an indication of nervousness in the financial community about the viability of the sector’s operations. The Economist in a separate article on December 6 writes that shale executives believe that $50 to $70 per barrel of oil is a required price range for the industry to be profitable, with the bright-line of profitability different due to different companies having different transportation costs and engineering techniques.
One of the biggest worries for the American economy would be a wave of bankruptcies by shale oil companies that bleed into the financial system. The Economist explains that debt for shale oil firms has doubled over 2009 levels to $260 billion today and that shale oil operations are 17% of the junk bond market. Junk bonds are high-yield bonds that provide a higher return for lenders, but carry a higher risk that those receiving the money will go under and thereby be unable to pay back their borrowers. One of the reasons that investors have poured money into shale oil operation is because of low interest rates. Foreign Policy explains in an article previously cited from December 10 that private portfolio funds have directed their energies since 2008 toward riskier projects that carry a higher rate of return. Investments in the energy sector were deemed less risky than going back into subprime loans, which are loans given to people who are at a high risk of defaulting. Investment has risen nearly 16% in energy bonds over the last decade, but a wave of bankruptcies would endanger this sector of the high-yield bond market that is worth $1.3 trillion collectively. Financial hardship could also freeze the willingness of financial firms to engage in the energy sector, even for projects that are viable, and that could harm the efforts of American companies to expand operations in the future. Also, if the firms buying the bonds of shale oil operations receive nothing for their investment that could force some of those firms to go under as well, thereby prompting some consolidation in the markets among investment firms. It is unclear whether a contagion in the high-yield bond market could be as disruptive as the 2008 financial crisis, but it could dampen the mood of investors across the economy. Therefore, if extempers notice a rash of bankruptcies in the shale oil sector they should take notice.
The Effect of Low Prices on Prominent Oil Exporters
As previously stated in this brief, OPEC is not in a rush to cut back on production, but this decision has generated a lot of anger within the body. Countries such as Iran and Venezuela were not happy about the cartel’s decision because they are in dire need of higher oil prices to keep their economies going. Russia Today on December 11 writes that Iranian President Hassan Rouhani claims that falling oil prices are “treachery” against Muslim people and he blames Saudi Arabia, who Iran jostles with for regional influence, of allowing prices to fall to further its geopolitical aspirations. The Washington Times on December 10 reiterates these accusations by pointing out that Iranian leaders fear a declining oil price will hurt its ability to extend patronage to Sh’ite allies in the Middle East. There have been some discussions that falling oil prices will shatter OPEC unity, such as those found in The Business Insider on December 9, but The Harvard Business Review notes on December 11 that falling prices need not mean that OPEC is on its way out as a prominent international body. Although some members such as Iran and Venezuela may not like the decision to keep prices low, The Harvard Business Review argues that the Saudis are acting in the organization’s best interest because the cartel will benefit when “bully pricing” forces out Western competitors. It is very unlikely that OPEC is going to fracture as a result of the low oil price. It is even possible that OPEC could convene before its next meeting in June and decide to cut production. Finally, this is not the first time that OPEC has endured a severe price swing as they went through one in the 1980s. As previously stated in this brief, OPEC recovered from that one as well and oil prices eventually moved over $100 per barrel in the 2000s. Oil prices may not suddenly recover, but it is very likely in several years that OPEC will be just as prominent in global oil markets as it is today.
OPEC’s decision not to cut back on production and play a long game does not mean that Saudi Arabia is not losing money, though. The Wall Street Journal writes on December 8 that it will lose $117 billion in revenue if current oil prices hold for the next six to eight months. Similarly, Kuwait could see losses of $32 billion, equivalent to 20% of its GDP. However, these nations, unlike others such as Venezuela, have more flexibility due to their accumulation of reserve currencies, especially dollars, and the fact that their governments have run few large deficits. The Wall Street Journal article provides a map of which countries stand to lose and gain the most from low oil prices and highlights how the Republic of Congo, Equatorial Guinea, and Angola stand to lose billions of dollars in oil revenue, potentially causing significant economic hardship.
As noted several times in this brief, Venezuela is one of the nations in the world that is hardest hit by the slump in oil prices. For more than a decade the country has utilized its large oil reserves as a way to win allies and bring in revenue for its socialistic “Bolivarian revolution.” Prior to the decline in oil prices, the country already faced some economic difficulties with an inflation rate higher than any other country in the world, a large budget deficit, and reduced foreign investment due to government expropriation policies. Foreign Policy reveals on December 12 that the country’s economic problems will be compounded by low oil prices because that is less money for President Nicolas Maduro to close the country’s looming budget deficits. With economic unrest steadily rising in the country, low oil prices in conjunction with looming American sanctions may signal the beginning of the end of Maduro’s regime.
Low oil prices are also threatening Russia, who has spent much of the last two years giving the international community fits with Ukraine, thwarting elements of the international community’s efforts on Iran’s nuclear program, and angering the liberal Western world over its anti-homosexual policies. Russian President Vladimir Putin prides himself on rebuilding Russia’s image after its 1998 financial crisis, but much of that rebuilding effort came from the rise in global oil prices during the twenty-first century. Now that prices are moving downward and that, rather than Western sanctions, might be what is finally needed to weaken his popularity at home. The Washington Post on December 2 notes that 61% of Russians believe that the economy is getting worse and Russian Finance Minister Anton Siluanov has said that Russia will lose $90 to $100 billion this year due to declining oil prices. The Guardian on December 11 writes that Russia needs $105 per barrel for the government’s budget to break even, so for every $10 decline in a barrel of oil from that figure it loses $12 to $14 billion. The Russian government still has a large pool of foreign currency reserves, but inflation is rising as the value of the Russian rouble falls since fewer people need to obtain the currency to purchase Russian oil assets. Since the debt of many Russian enterprises is owed in euros and dollars, the rouble’s decline in value relative to those currencies actually makes those debts harder to repay. Therefore, if you end up talking about Russia in the next several months, you should make note of low oil prices as they may hinder Putin’s ability to bully his neighbors since he will have to show he is confronting the country’s flagging economic fortunes to maintain his popularity.
Another good case study for falling oil prices is Nigeria, whose government relies almost solely upon the country’s vast oil reserves to maintain its operations. The Council on Foreign Relations provides a great summary of Nigeria’s oil economy on December 11. It explains that 80% of the Nigerian government’s revenue comes from oil and oil is 90% of the country’s exports. Politicians have been known to steal billions of dollars in oil wealth from the country in the past and the country is heading for new elections on February 2015. Lower oil prices mean that the existing Nigerian government of Goodluck Jonathan will have fewer resources on hand to give out to local leaders to win re-election next year. It also means that he may find it hard to acquire the funds necessary to beat back the Boko Haram insurgency by being unable to acquire better weapons and training for the Nigerian military. Furthermore, lower oil revenues will strain the Nigerian budget, as the government will be forced to consider unpopular austerity measures and even a reduction of the country’s popular oil subsidy. Jonathan would prefer to avoid these courses of action, especially with an election looming, but he may have no choice. The significance of the Nigerian example is that it is Africa’s largest economy when one accounts for GDP and it is one of two African states – South Africa being the other – that would be most in line for a UN Security Council seat if that body expanded. Extempers should make sure to bring in the oil question if they discuss the fight against Boko Haram or the upcoming Nigerian elections because oil is intertwined with each issue.
Lastly, the drop in oil prices may force other governments around the world to change their monetary policy, especially from oil producing states. The Nigerian government was already forced to raise interest rates due to low oil prices eroding the value of its currency, the naira, and causing the price of foreign imports to rise. The Guardian previously cited from December 11 notes that the Russian central bank raised interest rates by 1%, establishing a new rate of 10.5% to thwart similar inflation fears. Bloomberg on December 11 writes that Norway, Western Europe’s largest oil producer, recently saw its central bank cut interest rates by a quarter of a point to 1.25% in order to account for a possible decline in economic growth due to low oil prices. The Globe and Mail reveals on December 11 that Canada may look to avoid raising interest rates as quickly as expected due to the recent fall in oil prices, which may hurt employment in the country’s shale oil industry. Lower oil prices may also lead to the Federal Reserve keeping interest rates low in the near future because the decline of oil prices may remove some inflationary threats to the economy and because employment may decline as the oil and natural gas sector employs fewer people. Therefore, extempers should not forget the monetary and inflationary element at play due to the decline in oil prices around the world.
Global oil prices will stay below $100 for the foreseeable future. With that lower price will come a boon to some nations such as the United States – although the shale oil industry may beg to differ – and will create some hardship for states that rely on oil sales such as Venezuela, Nigeria, and Russia. Extempers should continue following the trajectory of the global oil price and use it throughout the rest of the season in their speeches because domestic and international political and economic issues will be greatly affected by it.