WASHINGTON – Are rapidly plunging oil prices just the logical outcome of a sudden collapse of global demand, just like what happened after the 2008 financial meltdown? Is it really all about China’s dramatic slow down, and US cars all of a sudden becoming more fuel efficient? Or is there a “US-Saudi plot” aimed at hurting Iran, Russia and Venezuela, unfriendly countries whose economic survival depends largely on high oil prices?
OPEC not following the old script
Nobody knows really. However what we do know is that the OPEC cartel, (a group of mostly Arab nations that produce more than 30% of global oil supply), is not following the old script.
In the past, when confronted with periods of lower demand, the OPEC countries agreed to cut their oil output in order to support global prices. Well, now we see the exact opposite. We see rapidly falling prices and increased output, offered at a discount to Asian customers.
Saudi plot?
Is this therefore a Saudi-inspired price war aimed at undercutting Iran and Russia? Analysts speculate. But nobody knows. However, it is clear that both Russia and Iran, already under siege because of economic sanctions, will suffer much more than other oil producers, should low prices persist. Oil revenue is their major source of income. State budgets are financed with crude revenue. Low oil prices spell trouble.
That said, while Saudi Arabia can endure lower prices much longer, it also needs oil above $ 90 a barrel in order to finance its large public expenditures that include various subsidies for the poor, aimed at insuring the monarchy against social upheavals.
Low prices hurt US shale oil producers
Last but not least, persistently low oil prices will hurt many American energy companies. Indeed, the shale oil boom in the United States has been made possible by high oil prices. In the US, shale oil extraction, the great technological marvel of the last 10 years, becomes economically attractive only when global oil prices are at least above $ 85 per barrel. And this is because it is a lot more expensive to extract oil from shale formations.
Should oil prices go below $ 85, and stay there for a long period of time, most marginal US shale producers will slow down, or stop drilling altogether. Otherwise they would start losing money.
It is possible that this new pressure caused by plunging prices will incentivize US energy companies to improve their shale oil extraction methods, in order to cut costs. But, even assuming that better technologies will be developed, this may take a long time. In the interim, it is hard to believe that US shale oil investments will continue at the same pace. Oil prices are simply too low.
A tax cut equivalent for consumers
For the time being, with gasoline prices down, the average consumer in America and across the world will benefit. Low fuel prices are the equivalent of a giant tax cut, favoring mostly lower income people who really depend on their cars to go to work or to run their business.
When will this end?
Nobody really knows how long this rather extraordinary low oil prices season will last. If it were just a demand and supply misalignment issue, then we could assume that crude oil prices will be stabilized when production will be adjusted down to actual demand. If there is more involved, namely political goals concocted by the Saudis, with our without a secret deal with Washington, then it is really hard to say.
Common sense tells us that at some point abnormally low oil prices will start hurting Saudi Arabia itself. But we do not know when. And it is a safe bet that Iran and Russia will suffer a lot more and a lot sooner.
However, I still do not see the end game here. Unless low prices can be enforced indefinitely, causing widespread discomfort among all oil producing countries, sooner or later this unusual “low price season” will have to end.
Force political changes in Iran?
That said, are the Saudis really hoping that the significant loss of revenue caused by their low prices policies will be enough to ruin Iran, may be forcing political changes in Tehran? This may be possible; but it looks like wishful thinking.