Effects of the slump in oil prices

While the price of oil has dropped substantially, it is imperative to note that the price of oil is linked to energy intensive service and goods production as well as the prices for other fuels.


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Oil, by both value and volume, is undoubtedly the largest internationally traded good. This has brought about a less than stable hydrocarbon economy. While the price of oil has dropped substantially, it is imperative to note that the price of oil is linked to energy intensive service and goods production as well as the prices for other fuels.

Abrupt changes in this hydrocarbon economy, such as under or oversupply, breeds a wide array of ramifications on both oil producing and consuming countries.

The sharp dip in global oil prices convincingly qualifies for the abrupt changes category. An evaluation of the impact of the world is critical to fully understand how devastating or even beneficial such prolonged prices will have on involved parties.

Venezuela is one of the largest exporters of oil with some of the cheapest prices in petroleum. It was reported that subsidies cost the capital, Caracas, over $12 billion per year. In perhaps a politically obstinate move, President Nicolas Maduro has declared that the country will neither enforce higher prices or remove the subsidies. This is against the back drop of an over 60 per cent inflation, which has positioned the country to fall into a recessional spin.

Economic mismanagement has not helped their case. Interestingly, the government’s cautious approach in not increasing prices could possibly be because they wish not to have a repeat of the 1989 petrol price increase riots that resulted in the deaths of hundreds of people.

Saudia Arabia, on the other hand, is the pearl of the oil producing world and inarguably the Organization of the Petroleum Exporting Countries’ most influential member.

Saudi Arabia has such power that if it would cut back on its production, the global oil prices would return to to normal. However, Saudia Arabia has shown no indication of being a team player.

It is probable that the country’s nonchalance stems from its selfish desires to pressure the booming shale and oil industry of the United States and teach the members of OPEC discipline; but the most suspected reason is Saudia Arabia wants to knock out the competition.

The country has deep reserves, approximately worth $700 billion, and therefore can withstand low prices for a relatively long time. The logics behind this strategy is that the current affair of low oil prices will force higher cost producers such as Russia to shut down and in doing this, Saudi Arabia is optimistic about snapping up those newly available shares in the market; a long term plan, indeed, and a brilliant one at that.

However, onlookers must remember that Saudia Arabia employed this exact strategy in the 1980s and the result was a badly affected Saudia Arabian economy. Will the same strategy produce a different result?

Russia is another country heavily dependent on oil exports. It is one of the largest oil producers, with over 70 per cent of its income coming from the energy exportation sector.

The World Bank has predicted that Russia’s economy will downsize by 0.7 per cent if oil prices continue to slide. This forecast was built from the fact that the nation hemorrhages $2 billion for every $1 drop in oil prices.

This is beyond significant, but despite the assessment, Russia refuses to cut production citing that a cut in production will see an increase in demand by importer countries, and by extension the inevitable loss of their niche market.

Russia’s issues deepen even more: the western imposed sanctions on it over its support of the separatists in Eastern Ukraine has caused more harm than good. As a result, Russia’s chances of avoiding a recession are miniscule.

U.S. oil production levels are at their highest in 30 years. The extraction of gas and oil from shale formations via hydraulic fracking has been a major cause for the decrease in oil prices. Head of energy strategy at Citi, Seth Kleinman, said, “Shale has essentially severed the linkage between geopolitical turmoil in the Middle East, and oil price and equities.” This, in the American context, is an additional gain.

When discussing U.S. fracking, it’s also important to mention that it’s been a key factor in reducing greenhouse gases. President Obama has gone against many in the environmental movement that support him in order to push for natural gas extraction. Moreover, fracking has led to increased tensions between the U.S. and OPEC.

Like Saudi Arabia, United Arab Emirates, Kuwait and the other Gulf producers have accumulated massive reserves, which means they can absorb losses for some time as well without being devastated.

On the other hand, other OPEC members, including Nigeria, Iraq and Iran, are more limited in this regard, especially when one considers their great budgetary demands and dense populations. Their oil revenues must be consistent and sufficient at the same time. Elsewhere, the European countries have mixed feelings towards the situation.

With economies characterized by weak growth and low inflation, low oil prices are welcomed. Mathematics says that a 10 per cent decrease in prices will translate into a 0.1 per cent growth in economic output. A country like China, which is the largest net importer of oil, is set to benefit. Similarly, India imports over 70 per cent of its oil and thus, falling prices will ease the deficit on its current account. Low prices bring mixed blessings for Japan, even though it’s an importer of oil. The high inflation incited by the equally high oil prices is a critical political part of the current Japanese administration’s growth strategy to combat deflation.

And finally, for Canadians the drop in oil prices has also had mixed results.

For one, the consumers are happy. Seeing prices drop below a dollar a litre has made life easier for anyone with a car, but there’s a downside.

Provincial governments are having trouble balancing their books, and premiers like Kathleen Wynne are contemplating a carbon tax. While that would work with bringing government revenue up, the people at the bottom of the income scale would be hurt the most.

So globally, the ramifications from mass production of oil are numerous and intricate. While OPEC is aiming to get back the market share they’ve lost over the years, consumers are caught in a brutal tug-of-war.

It’s rumoured that OPEC will continue to produce more oil for at least two years, which leaves many governments scrambling for funds.

Hopefully, this crisis should serve as the ideal incentive for these countries to further diversify their economies.

 

 

 

 

 

 

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