Better for all if oil markets are stable
DEC 1, 2014
LAST week's refusal by the Organisation of the Petroleum Exporting Countries (Opec) to cut production, in spite of a supply glut and falling prices, underscores the complicated dynamics of oil markets. It is a significant shift in oil geostrategy, compared to when Opec and Saudi Arabia, the biggest producer, called the shots. With weakening global demand, greater competition among producers, and the shale revolution in the United States, oil price is said to now hinge on the marginal cost of non-Opec production - much higher for deep-water and shale oil compared to conventional crude from the Middle East and North Africa.
Crude oil prices have fallen by more than a third since June and the organisation's capitulation to market forces, instead of a customary ability to set the terms of business in the oil bazaar, has raised questions about the relevance of Opec, which accounts for a third of the world's oil production.
Many would be gladdened by the weakening of the oil cartel, as of any other. Historically, oil price spikes have been associated with wider economic dislocation, notably in the 1970s, when a single commodity became a major political tool to hold the world hostage. A sharp spike in oil prices has been cited as a factor in the 2008 global recession as well. Given the strategic importance of oil, people would welcome the decline in the ability of any set of players to use it to determine wider outcomes. Still, none should rule out a reassertion of group interest should Brent crude sink to, say, below US$60.
In purely economic terms, today's falling prices are good news for the oil-consuming regions of Asia, America and Europe. Their economies should receive a sizeable stimulus in the form of more consumer spending born of greater confidence. Although lower prices would add pressure to the budgets of a good number of oil producers, their losses would be outweighed by gains made by consumers around the world, who would heave a sigh of collective relief. Indeed, the low oil-price regime has helped Indonesia to cut subsidies, a move that would have been politically punishing had prices been much higher, inflicting that much more pain on consumers.
However, a serious downward spiral in oil prices would bring about a new set of problems. If prices fall too low, they will reduce the incentive to invest in exploration and affect supplies over time. Meanwhile, excessive consumption spurred on by low prices would be destructive environmentally, not least because less attention would be paid to low-carbon alternatives. Given the economic and strategic importance of oil, price stability therefore is the best scenario.
A subdued whoop over sharp fall in oil pricesDECEMBER 4
What does the decline in oil prices mean for the world economy? The answer depends on why it has happened and how long it might last. But overall, it should be helpful, albeit with caveats.
Particularly important might be the impact on net oil-exporting countries. Among vulnerable producers are regimes that one would dearly like to see weakened — President Vladimir Putin’s Russia foremost among them. But even here the silver lining has a cloud.
As Mr Kirill Rogov of Moscow’s Gaidar Institute has noted, lower oil prices might exacerbate Mr Putin’s revanchism, or a policy of seeking to regain lost territory.
Between late June and the beginning of this month, the price of crude oil fell by 38 per cent. This is a big decline. But a bigger one occurred between the spring of 1985 and the summer of 1986.
The sharp fall in the early to mid-1980s — not coincidentally, the event that preceded the collapse of the Soviet Union — was caused by two developments: The reduction in the energy intensity of consumption and production triggered by the two oil shocks of the 1970s; and the emergence of significant production in non-OPEC (Organization of the Petroleum Exporting Countries) nations, such as Mexico and the United Kingdom.
The story this time is not so different, particularly on the supply side. The International Energy Agency’s latest World Energy Outlook shows that supply of non-OPEC oil and natural gas liquids might rise from 50.5 million barrels a day (mbd) last year to 56.1mbd in 2020.
This would raise the share of non-OPEC producers in global production from 58 per cent to 60 per cent. As much as 64 per cent of this increase is forecast to come from North America. Behind the rise in the continent’s production is unconventional oil — so-called “tight oil” — in the United States and oil sands in Canada. Meanwhile, OPEC production is forecast to remain roughly constant.
The revolutionary developments in unconventional oil production have made a substantial difference to production. US production of liquids has risen by 4mbd over the past four years. HSBC said US output is expected to rise by 1.4mbd this year. Libya’s output is also recovering.
Finally, unexpected economic weakness in the eurozone, Japan and China has cut estimates of global demand by 0.5mbd this year. To sustain oil prices, OPEC needed to cut output by about 1mbd. But it — or, more precisely, Saudi Arabia — has refused to do so. This has triggered the recent fall in prices. Will these low prices last, or might they go even lower?
I am not foolhardy enough to forecast oil prices: The price elasticities are so low and the margins between supply and demand so fine that it is all too easy to forecast wrongly.
The case that the decline will prove temporary is that Saudi Arabia’s desire to cripple production of unconventional oil, which demands a high level of capital expenditure, will swiftly succeed. Moreover, the lower oil prices, a hoped-for economic recovery and continuing rapid growth in emerging economies could boost demand for oil.
In addition, HSBC said global spare capacity is still very tight by historical standards and largely concentrated in Saudi Arabia. Having made their point, the Saudis might yet cut production.
IMPACT OF LOW OIL PRICES
At this stage, it seems unclear whether we are witnessing a lasting structural downshift in prices. But let us assume they last for quite a while. What would be the consequences? Here are six.
First, a US$40 (S$52.30) fall in the price of oil represents a shift of roughly US$1.3 trillion (close to 2 per cent of world gross output) from producers to consumers annually.
This is significant. Since, on balance, consumers are also more likely to spend quickly than producers, this should generate a modest boost to world demand.
Second, the fall in energy prices will lower already-low headline inflation.
This creates two offsetting risks. One is that it might entrench expectations of ultra-low inflation. An opposite risk is that it might encourage central banks to ignore threats of rising underlying inflation. On balance, the former is at present a greater threat than the latter.
Third, the fall in energy prices will boost the profitability of energy-intensive production.
At the same time, it is cutting the profits and capital spending of oil producers. It could create significant bankruptcy risks in the energy sector, particularly among the more highly-leveraged oil producers. How far that would also damage lenders is unclear.
Fourth, the fall in prices will redistribute income from net-exporting countries to net importers.
Among the latter are the eurozone, Japan, China and India. The US is now a net exporter. But the important net exporters are countries that are heavily dependent on these revenues. These include Iran, Russia and Venezuela. It could not happen to nicer regimes! But there is also danger when despots are in a corner.
Fifth, the fall in energy prices will create shifts in asset prices.
The exchange rates of energy-producing countries will be under downward pressure, already seen in the sharp fall in the Russian rouble. Shares in companies that benefit from lower oil prices, directly or indirectly, will rise. This might create new stock market bubbles.
Finally, falling oil prices threaten to make economies more carbon-intensive and less energy-efficient.
But they also give an opportunity to raise taxes on oil or at least cut wasteful subsidies to consumption permanently. It is an opportunity that any sensible government would seize. Needless to say, the supply of such governments is rather small.
Much uncertainty remains over how low prices will go, and for how long. But to the extent that they reflect strong supply rather than reduced demand, they offer a welcome boost to the world economy. They also represent a welcome transfer of income from unattractive petro-despotisms.
It is hard not to cheer that, even if the opportunity for lower subsidies and higher taxes will yet again be thrown away.
THE FINANCIAL TIMES
ABOUT THE AUTHOR:
Martin Wolf, the chief economics commentator at the Financial Times, is widely considered to be one of the world’s most influential writers on economics
Dec 02, 2014
Who are the winners and losers when oil prices plunge?
The months-long price slide, from a sluggish global economy and a boom in US shale oil production, accelerated in the last few days after oil cartel Opec announced last Thursday it would keep pumping rather than cut output - in a risky game of chicken with US producers to see who will blink first.
Obviously plunging oil prices is a bonus for consumers and companies when prices fall at the pump, giving individuals more spending money and lowering costs for many businesses, particularly airlines.
Christine Lagarde, head of the International Monetary Fund, said on Tuesday: "There will be winners and losers, but on a net basis it's good news for the global economy."
Here's a closer look at who wins and who loses.
RICH OIL EXPORTERS
Saudi Arabia, Opec's biggest producer, and Qatar and Kuwait, who have the lowest production costs, are potential winners in the battle with their US rivals. These three will definitely benefit if Opec can wrestle back market share from US producers longer-term.
The problem for them is that Opec's once mighty influence on the oil market has declined and the forces of demand and supply now rule. Bloomberg estimates that global oil production is running at just under 31 million barrels, while global demand is running at just over 29 million barrels a day.
Opec's gamble, therefore, may not succeed.
Verdict: Still out
POOR OIL EXPORTERS
The big losers when oil prices crash are Opec's poorer members that depend on oil exports for the bulk of their revenue.
Countries like Venezuela and Nigeria do not have the same low cost of production or sizable foreign reserves as Saudi Arabia does, and will be very hard pressed to maintain their social programmes. Once those social programmes are cut, there could be social strife that destabilises governments and the region.
In Venezuela, which argued vehemently for an Opec supply cut, oil production has been steadily declining for years so the combination of lower output and lower prices is already squeezing finances with the result that President Nicolas Maduro announced on Friday steep cuts to government spending - starting with his own salary.
In Nigeria, the naira tumbed to a fresh record low on Monday on fears over the impact of plunging oil prices on Africa's biggest economy.
The central bank devalued the currency by 8 per cent against the US dollar last Tuesday in a bid to halt a decline in the foreign reserves of Africa's leading energy producer, but has struggled to keep the currency in its target range since then, Reuters reported. The country's woes are exacerbated by the fact that Nigeria's oil savings actually fell when oil prices were at record highs, partly owing to theft of its oil by criminal gangs, hurting output.
The economy was already sliding into recession under the impact of Western sanctions. Oil and gas provide 68 per cent of Russia's exports and 50 per cent of its federal budget, so the country will be hit hard.
For Russian consumers, pump prices have actually gone up because the falling ruble has increased inflation. In local money, 95-octane gasoline costs now costs 35.99 roubles (S$0.92) a litre in Moscow, up from 35.53 per litre two months ago, AP reported.
Declining energy prices had already sharply depressed the rouble. Following Thursday's Opec decision meeting, it dropped another 3.6 per cent for a 35 per cent loss against the US dollar so far this year.
As the world's largest oil consumer, it stands to benefit the most.
Drivers in the US are enjoying the lowest gasoline prices since 2010 with pump prices as low as US$2.79 on Friday. Tom Kloza, chief oil analyst at the Oil Price Information Service, told news agency AP he expects gas to eventually be a full US$1 per gallon below its June peak of about US$3.70 a gallon. That would save the average American household about US$60 a month for those that burn 60 gallons of fuel.
But for US oil companies behind a production boom, the news is not so good. Crude produced in Canadian oil sands, deep offshore in the Gulf of Mexico and in some US onshore shale formations is some of the most expensive oil to produce in the world, said AP. Drillers will have to cut back - some may even go under - if profit margins are squeezed hard enough. Shares of Continental Resources Co., one of the biggest US producers, fell 20 per cent on Friday, a day that virtually every energy company's stock fell.
It's not just energy stocks feeling the heat. US funds have played a big part in bankrolling the US shale boom, gobbling up billions of dollars of junk-rated bonds issued by energy companies to rapidly expand production, Reuters reported. In recent weeks, prices of some of these bonds have collapsed as oil prices have tumbled by a third since June to four-year lows, raising fears of a new, albeit smaller, credit crisis.
Verdict: Overall win
Sluggish Euro zone economies will get a small boost from lower oil prices boosting consumer and business spending.
In Germany, the price of Super E10 fuel has fallen from 1.53 euros (S$2.49) per litre at the start of September to 1.42 euros per litre this week, AP reported.
On the other hand, the oil price slide is depressing consumer prices that are already close to stagnating. "Lowflation" or weak inflation is a real threat to the euro zone especially for economies like Greece still struggling to reduce debt. It is also a problem for the European Central Bank, which wants to boost inflation from just 0.3 per cent currently to around 2 per cent.
The few European oil producing countries - mainly Britain and Norway in the North Sea - face a drop in revenues that could balance out the positives of cheaper fuel, AP noted.
Verdict: Double-edged sword
Japan is another big net importer of oil but cheaper crude prices have been slow to filter down to consumers, AP reported. The recent decline in the yen has also offset the savings from lower oil prices.
Regular gasoline which cost US$1.40 a litre at the Esso station in Shimbashi, near Tokyo's Ginza shopping strip, actually cost slightly more - US$1.44 a litre - on Friday.
Pump prices should eventually come down but this will make it harder for the government to fight falling consumer prices or deflation.
Verdict: Overall draw
Chinese consumers and businesses are benefiting from cheaper fuel. The government has cut pump prices repeatedly this year and on Friday, highest grade gasoline cost US$1.20 a litre in the capital, down from US$1.35 a litre in June, AP reported.
The price slide has also given China, the second-largest oil consumer, the opportunity to build up its strategic oil reserves at lower costs. It is also offering Chinese energy companies the chance to buy distressed energy assets.
OTHER ASIAN ECONOMIES
Elsewhere in Asia, the impact is varied.
In big oil importers like Singapore, slumping crude prices will lower inflationary pressures and benefit households and most businesses. But a prolonged decline will hurt key sectors of the economy like marine and offshore engineering and petroleum refining.
In Indonesia, fuel costs have risen because the government has cut subsidies, more than offsetting the decline in global oil prices. The higher prices triggered street protests, so the latest fall in crude prices may help ease tensions, according to AP.
Malaysia is among the few oil-exporting nations in Asia, so the drop is hurting its coffers but it has also helped the government to cut expensive fuel subsidies.
Verdict: Overall win