By Hasan Selim Ozertem
JTW
Photo courtesy of Freedigitalphotos.net/Suwatpo
Oil prices peaked in June 2014 at $115 per barrel when ISIS entered Mosul. But after this date, the oil prices started to regress and even slipped below $90 per barrel, surpassing the psychological threshold of $100 per barrel. Even falling below $81 per barrel of oil, the average price of Brent crude oil leveled out at $86 between September 29 and October 27.
These low prices are pleasant for the countries such as Turkey which are dependent on imports for 91-92% of their oil. This is because each one dollar decline in the average annual price of oil roughly reduces the current account deficit by $400 million. The sinking global oil prices also provide lower transportation costs for consumers, even though a decline in prices at the pump may take longer to make itself apparent.
The situation is different when it comes to global trends. The fluctuations in the market and the period in which these fluctuations are occurring have varying effects on producers and consumers. That a 25% decline in oil prices came to be witnessed just a few months after experts started to accept $100 per barrel as the standard price has sparked some debates with regard to oil supplying countries. These debates can be organized under three main headings: the state budget performances of those oil producing countries that are dependent on oil prices, the circulation of hot money in the global economy and the dynamics of production in the upcoming period.
The Dilemma of OPEC and Balanced Budgets
If we consider budget performances, countries rich in oil and gas makes financial adjustments to the budgetary income and expenses each year depending on predicted oil prices. While the countries that are dependent on oil revenues such as the Russian Federation, Venezuela, Iran and Saudi Arabia are negatively affected by the decrease of market prices, they generally benefit from rising prices in a market where $100 per barrel is commonly accepted as standard.
The oil market cartel OPEC attempts to regulate the market in order to minimize these fluctuations by deciding whether to increase or reduce production. At this point, the role of heavyweight Saudi Arabia in this process should not be denied. In this context, Isaac Arnsdorf from Bloomberg, emphasizing the power of Saudi Arabia, remarked that this country has the distinct advantage to determine the winners and losers as it is the largest oil producing country in the world. Saudi Arabia needs an average oil price of $83.6 per barrel to balance its budget in 2014. In this regard, it seems that the decline in prices does not directly impact Riyadh. Here, the Saudis increased their oil production to 9.65 million barrels per day in September to offset the loss in revenue that arose from the declining prices.
The other oil producing countries are not as lucky as Saudi Arabia. While the oil prices continue to decline based on the oil surplus in the market and the slow-down in demand growth, the other OPEC countries are negatively affected. Libya’s OPEC Spokesman Samir Kemal has called for a decrease in the production quotas by 500,000 barrels per day in order to give the market a strong signal before the OPEC Summit on November 27 in Vienna. He also claimed that there is a market surplus of one million barrels of oil. The decision of OPEC is quite important because this group of countries controls one third of the oil market with a rate of production of 30.9 million barrels of oil per day. But Saudi Arabia signals that it does not want to be the only country to cut oil production when countries like Iran and Iraq aim at increasing their production in 2015. In this regard, Saudi Arabia considers that the burden of production cuts should be shared by all OPEC members.
For the Russian Federation the situation is a little bit different considering that this country has up until now reaped the benefits of OPEC’s regulation of the market. Moscow should closely follow oil prices because of recent developments such as the more than 25% devaluation of the Russian ruble against the US dollar, the pressure instated by European and US sanctions, and the desire of Putin’s government to realize certain reforms that would increase the government’s expenditure. The current trend is not too pleasant for Putin’s government, which will experience a budget deficit if oil prices stay below $100 per barrel in 2015. Russian Finance Minister Anton Sulianov stated in September that the decline in crude oil prices makes it necessary to review, renew and administer some serious changes to the decade-long plan to modernize the Russian Army. As the pressure exerted by the ongoing $80-90 price levels is expected to continue to take a toll on Russia’s wallet, experts remark that in the context of current financial dynamics the Russian economy will become increasingly affected by this situation over the next two years.
Hot Money and the Oil Supply Surplus in the Global Economy
The pressure that has been placed on the economies of oil producing countries as a result of the decline in oil prices may weaken the flow of and demand for hot money. In other words, when it comes to the global economy, very high and very low prices produce negative results. When oil prices are at high levels, oil producing countries tend to increase domestic construction and social spending thanks to the surpluses in their budgets. This inclination brings with it economic growth because it triggers production. But a decline in prices causes demand to shrink, therefore flipping the picture as it relates to economic growth trends. At first glance, it may be expected that this situation exhibits regional effects only. Nonetheless, when considering the effect on the global economy that cheap financing has had, which has been based on the surplus in capital of the countries whose incomes are generated by expeditiously increasing oil revenues, a shrinking money supply will be inevitable with these falling oil prices. In this respect, a loss of momentum in capital flows, which are fundamental for developing markets, may result in a slowdown of global growth trends.
On the other hand, another risk is the deceleration of the global oil supply growth rate. Neither the rise of oil production nor the appreciation of the US dollar should be ignored, as both of these factors have effects on today’s decline in oil prices. In this regard, the positive results that have come from offshore energy resource exploration and the gains made in developing shale-oil production in the US have rapidly increased the oil production of non-OPEC countries. While a slowdown in the upward direction of global oil demand is expected, a heavy increase is occurring in production. Therefore, oil prices are regressing despite the geopolitical risks. When we examine the oil production data from 2007, the US produced 5 million barrels per day. This production rate increased to 8.5 million barrels in 2014. This increase indicates an important change in the parameters of supply. As the US now starts to compete with Russia and Saudi Arabia in terms of oil production and as its demand for oil imports shrinks, fundamental balances have begun to shift. But considering that shale oil production costs range from between $50 and $100 per barrel of oil extracted, it is commented that each $10 decline in oil prices renders some oil wells economically inefficient. Therefore, according to this, the investment in new wells will abate and production at some wells may even be halted. Such a situation would prevent the US from attaining the capacity to produce over 9 million barrels of oil per day in the future. Furthermore, if the decline in oil prices persists, offshore resource exploration will also slow down due to its costs.
When all factors are taken into account, it is important to ask the question of whether the fluctuations in the oil market are a short term correction or a sign of a long term bear market. If the decrease in prices lasts for a short amount of time, the market will stabilize without needing to implement the aforementioned mechanisms. However, some pessimistic commentators claim that the decline will continue and that equilibrium will first be achieved at around $60-$70 per barrel. If this forecast comes to fruition, it may be necessary for different mechanisms to come into play. From this point of view, the fundamental problem should be assessed in terms of at what price the oil market equilibrium will be reached and for how long it will remain there, not in terms of the range of oil price fluctuations.
This article was first published in Analist Monthly Journal, November 2014.
Translated into English by Cemre Nur Öztürk
Courtesy of JTW
JTW – The Journal of Turkish Weekly – is a respected Turkish news source in English language on international politics. Established in 2004, JTW is published by Ankara-based Turkish think tank International Strategic Research Organization (USAK).
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