1. Oil Prices in Today’s Economy
A Report Prepared by Saad Hirani
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Note: A college student wrote this report. Feedback is welcome!
We’ve seen crude oil prices become the hot-topic in the global economy these past few
months. Industries such as the airline and transport industries, firms trading in commodities,
global stock exchanges – name an industry and you could bet they’ve been keeping a
close eye on OPEC and non-OPEC members fighting for market share and leaving oil prices
volatile, oil markets risky. This report briefly introduces how this struggle of pricing and the
battle for market share began, and explores what lies ahead in the coming months.
What actually happened? Oil prices fell from above $110/b last year in mid-2014 to below
$50/b at the beginning of this year. Collapsing prices hurt many oil-producing economies
that were dependent on the black gold for a majority of their export revenues, but at the
same time decreased costs of production worldwide, giving a significant relief-gift to
companies heavily dependent on large consumption of energy for production. The average
American was a happier man, because his petrol/gas consumption bill declined
significantly. But consequences of low prices were hard felt in the global economy, which
relies heavily on oil prices for economic growth and inflationary pressures.
Let’s Take the Positives, First: Lower oil prices gave a much-needed temporary hope of
revival to the dying manufacturing economies, especially in the Euro-zone. Emerging
economies in the developing world also made the most of lower net-import bills, and often
doubled up on lower imports by not only getting rid of energy subsidies, but also decreasing
interest rates and increasing economic growth in their regions (This was done in India,
Indonesia and other Eastern, non-oil producing countries). Oil exporting giants such as Saudi
Arabia, Qatar and others had prepared themselves by cushioning for the impact of lower
2. prices by accumulating other foreign assets. The average household’s purchasing power
suddenly rose, and global economic spending forecasts smiled at the IMF and leading
economies for the first time in a few years.
It’s Not a Fairytale Though: Many oil producing economies such as Russia, including some
members of the OPEC (Venezuela, Libya) took a significant hit and dived towards recessions.
Heavily reliant on oil revenue with their policies invested in black gold, these economies
possessed large costs of producing barrels and remained unable to trade competitively at
lowering prices. Public budgets in such countries have been cut heavily; with governments
risking social and political turmoil for the sake of makes their budgets meet. Second order
effects also began creeping in, with large oil corporations such as Chevron, cancelling major
development projects with $10bn. Goldman Sachs estimated that low oil prices put $1tn of
investments at risk. Construction companies, energy sector related companies; all were
pulling back on work projects, as ends could no longer meet.
That’s not it folks- we’ve forgotten about the whole matter of cleanliness and green energy
in this discussion; with minds completely focused on lowering oil prices, energy investments in
solar and other, more expensive forms of energy decreased heavily, putting the dream of a
clean economy at hold. The economic viability of cleaner energy sources was heavily reliant
on decreasing oil supply and high barrel prices; the class micro economic concept of the
substitution effect has knocked out wind and solar energy firms from the global energy
equation for now.
Why did Oil Prices fall so much? Everything usually tends to fall when America enters the
equation- everything from governments to oil prices. America finally found its golden
method of producing oil, and has increased production in recent years by 60% since 2009!
Though most crude oil exports are still banned, one of the world’s largest economies has
managed to reduce its oil imports to next-to-nothing. The decrease in American imports
caused a glut in global demand for oil. Shale production, horizontal drilling and hydraulic
fracturing methods have allowed the USA to decrease its cost of production of oil, to well
below the world price and hence the USA’s independence in it’s largest need has left global
producers lacking customers of its best product. The USA is slowly establishing itself as a
leader in the world economy for oil production, and its half-decade long surge may finally
have neared to breaking OPEC.
Breaking OPEC... You’re Joking Right? I found this hard to digest too, but I’m not. It’s time to
accept that the OPEC is not as strong as it once used to be, and that it’s slowly beginning to
3. lose its leverage over prices in the Oil Market. The cartel has not been able to cut back
supply and increase oil prices to reach the $100/b mark that many members of OPEC need
in order to break even on their investments and balance their budget. OPEC’s market share
in the global oil market has declined since a strong 50% hold in 1979 to about 1/3rd of the
global oil market. Whereas it’s large market share let it increase prices at will by restricting
supply, today, the threat exists that if OPEC increases its price, the USA’s additional pumping
ability will allow it to cut deeper into OPEC’s market share and only deepen wounds more.
As a result, OPEC itself is favoring such low prices. OPEC’s long term position and its strategies
are geared towards increasing production of crude oil and focusing on stimulating demand
for crude oil so that it can recapture its market share in the global oil economy. This policy
has been widely accepted as the best means going forward by many countries in OPEC
such as Saudi Arabia, but has led to a lot of anger among countries like Libya and
Venezuela whose break-even prices of crude oil are much higher than market prices at the
To sum it up, there finally is an element of ‘free market’ in the oil economy. There are more
than 4000 oil producers in the USA, and coordinating price controls with OPEC is impossible
to manage. Hence, the only way forward for OPEC is to pump more oil, in a last ditch
attempt to regain its market share and work to establish future credibility in order to dream of
manipulating prices once again in the future.
What Happens NOW? Well, OPEC’s been pumping record oil levels, having produced close
to 31m barrels a day for the first time since 2012. The USA isn’t backing down either, trying to
assert its dominance and prevent OPEC from regaining its share. The supply of oil in the world
market is far exceeding demand; by up to 2m barrels a day – hence, an inventory of
4. untraded oil is beginning to stock up. With neither OPEC nor USA willing to decrease
production in a race for leadership in the world’s most important commodity.
For OPEC, things don’t look too good. According to the IEA, demand for OPEC produced oil
is flat or declining; customers are either producing their own oil or are turning to non-OPEC
members putting OPEC countries at a severe disadvantage. The USA on the other hand, has
enjoyed more than $20bn of investments in oil startups in private equity, and Wall Street has
been kind to public oil companies, keeping the USA energy boom running well. In Q1’15, US
listed oil corporations reported a recorded $16.7bn in funding in convertible bonds.
With OPEC ministers declaring in their latest meeting in Vienna that they are optimistic of the
global growing economy and that they are confident in their ability to regain their market
share, and the USA energy market not even close to peeking, one thing is for sure – no one
currently leads the oil market, which is for the first time enjoying free market forces; the oil
market war is only just beginning.