Falling crude oil prices and the world economy

Crude oil prices have fallen on the world market by almost 50 per cent since June, 2014. Falling demand for oil, especially in China, because of weak economic growth, has been one of the causes of plummeting crude oil prices.

Besides, the introduction of alternative methods of producing oil and their use in the United States (US) have been the major drivers of the fall in oil prices. Shale oil produced through hydraulic fracking or fracturing has increased US oil production to the highest level in about 30 years. By October this year, American oil production had reached 7.7 million barrels a day -- from very little in 2009.

“Shale has essentially severed the linkage between geopolitical turmoil in the Middle East and oil prices and equities,” an energy analyst has said. Production of crude oil using tar sand is another alternative method that has helped to increase oil production and lower prices.

But according to Danny Gabbay of Fathom Financial Consulting, the use of hydraulic fracturing and tar sand is only a reaction to high oil prices. He attributed plummeting oil prices to “overwhelmingly, predominantly, if not entirely, a demand shock”. Danny Gabbay added: “It is China slowing down. The supply element is more of a reaction”.

At its November 2014 meeting, OPEC members decided not to react by cutting production levels, and that has also helped to keep oil prices low.

Crude oil prices had been stable and around $110 a barrel between 2010 and June this year – after the Global Financial Crunch of 2008 that plunged oil prices from $147 in July 2008, to below $50 in December the same year.

During the fourth quarter of 2014, prices of Brent crude oil produced in the United Kingdom fell below $60 a barrel and US crude oil below $55. As explained above, OPEC’s decision not to cut production targets is an important factor in keeping oil prices low.

Following the oil price slump of December 1989, OPEC decided to and used production cuts as a price-fixing mechanism that drove prices up progressively from nine dollars a barrel in December 1989 to $147 in July 2008. OPEC produces one-third of global total oil output. Production cuts could drive prices up.

Why are OPEC members now reluctant to cut down on supplies? OPEC’s resolve represents a change in policy. The group decided at its November 2014 meeting to keep production targets at 30 million barrels a day. The new policy, in effect, means that OPEC will not interfere with the forces of supply and demand by cutting down on supplies – even if prices fall to as low as $20 a barrel.

The Minister for Oil of Saudi Arabia, al-Naimi, has said of the new policy: “As a policy for OPEC, I convinced OPEC of this, even Mr al-Badir, OPEC’s Secretary-General, is now convinced – it is not in the interest of OPEC producers to cut their production whatever the price is”. “Whether it goes down to $20, $40, $50, $60, it is irrelevant,” al-Naimi added.

That means OPEC has, for once, abandoned production cuts as a price-fixing mechanism and now allows interplay of natural forces of supply and demand to determine price levels.

OPEC reckons that by the end of 2015, prices will hit $70 or $80 a barrel. That is possible, but the experts’ projection is that oil prices may never go up to as high as $100 a barrel again.

Does it mean that OPEC members are strong enough financially to afford the drastic drop in oil prices? OPEC members have, over the years, accumulated a lot of petroleum dollars and, on the surface, it appears that all of them are willing to let natural law dictate price levels.

However, some OPEC members would like oil price to remain at $120 a barrel for the sake of their economies.

The following figures provided by the International Monetary Fund (IMF) and Deutsche Bank show the levels of oil prices required by individual oil-producing countries to balance their respective budgets: Libya, $184 a barrel; Algeria, $131; Nigeria, $123 ; Venezuela, $118 ; Russia, $105; Saudi Arabia, $104; Iraq, $101; United Arab Emirates, $89; Kuwait, $78 and Qatar, $77.

Of all the oil-producing countries mentioned above, only Saudi Arabia, Kuwait and United Arab Emirates have huge reserve funds to meet budget requirements. Iraq, Iran, Russia and Nigeria are among oil-producing countries with insufficient reserve funds. How have falling crude oil prices impacted on economies of oil-producing as well as oil- consuming countries?

Generally, the fall in prices had adversely affected producing countries, but consuming countries are largely benefiting. According to the IMF, falling oil prices will raise global economic growth by 0.7 per cent in 2015. “We see this as a shot in the arms of the global economy,” IMF Chief Economist Olivier Blankard has said.

Russia, one of the world’s largest oil producers, is among nations hit hard by the drop in oil prices. Production and sale of oil and gas contribute up to 70 per cent of Russia’s total revenue from exports. One dollar fall in oil prices now means a reduction of two billion dollars in national revenue.

The Rouble, Russia’s currency, has fallen drastically in value and interest rates reduced to 17 per cent. According to the World Bank, Russia’s economy will shrink by 0.7 per cent in 2015 – if oil prices are kept low. Yet, Russia, like OPEC members, has resolved not to cut supplies.

The Russian Minister of Energy, Alexandra Novak, explained why: “If we cut, the importing countries will increase their production and this will mean a loss of our niche market”.

The Prime Minister of Russia, Dmitry Medvedev, has said: “Frankly, we, strictly speaking, have not recovered from the 2008 crisis”. Saudi Arabia has large reserve funds but according to the IMF and Deutsche Bank estimates, Saudi Arabia needs oil price at $104 a barrel for it to adequately balance its budget.

Venezuela, one of the largest exporters of oil and believed to possess the greatest oil reserves, has been hit badly by the slump in prices. That country is close to a recession, with inflation at 60 per cent and oil subsides about $12.5 billion a year.

China, the largest oil importer in 2013 (about 60 per cent of oil needs), is expected to gain from the price slump. Improved Chinese economy and more Chinese oil imports could drive oil prices up again. European countries are also expected to benefit from low oil prices. Analysts have indicated that a 10 per cent fall in oil prices would lead to 0.1 per cent economy growth for Europe.

India that imports 75 per cent of oil needs, and Japan that imports all its oil requirements, are also expected to gain from the fall in oil prices. Africa’s largest oil producer, Nigeria, is suffering from the drop in oil prices. Nigeria, since it derives about 90 per cent total export earnings from crude oil, has been badly hit.

President Goodluck Jonathan of Nigeria has admitted that the oil price slump would affect his country. He has said: “We are facing a lot of challenges now as a nation”.

The Nigeria President added: “The economic team is working hard to stabilise it and we believe that although there may be temporary inconveniences, it will definitely not bring the economy down”. Ghana, a marginal oil exporter, has less to lose, but the economy will benefit from low oil prices, especially if the gains are passed on to consumers.

(therson.cofie@yahoo.com)