What’s Oil the Fuss About?
When I want to fill up my Honda Civic with gas it costs less than $20. And that feels amazing. But there are more pressing concerns than me being able to finance my jelly bean addiction. Some countries are net exporters of oil, and some are net importers, but every country on earth relies on it. On January 6th, 2016, the price of oil tumbled to its lowest level in 11 years, at $35 per barrel. The underlying reasons for this fall are interesting in their own right, but the geopolitical consequences are potentially enormous.
Simply put, the supply of oil has risen and the demand has fallen. Oil demand is falling because the world’s fastest growing, and second-largest economy is slowing down. After growing at almost 12% in 2010, the Chinese economy is now at its lowest growth rate in 25 years, growing 6.9% in 2015. Fewer factories are consuming oil to create goods, and there are fewer goods to transport with gasoline, leading to lower global oil demand.
The root cause of the increase in oil supply is mainly due to the U.S. hydraulic fracturing (fracking) boom. The U.S. has used fracking to access oil deposits compressed within vast shale rock formations. The Organization of the Petroleum Exporting Countries (OPEC), which produces about 40% of the world’s crude oil, has not decreased its oil production in response to low oil prices. In the past, when oil prices dipped, OPEC would cut off some supply to maintain artificially high prices. Some analysts suggest that OPEC is hoping that the low oil prices will make fracking uneconomical and push U.S. oil producers out of business. A February 16th deal between Russia and Saudi Arabia to freeze oil output was designed to do just that. Yet the deal has thus far failed to check the fall in price. And finally there is the possibility that Iran will add even more oil to the global supply. Now that Iran is re-integrating itself into the global economy after its nuclear deal, the Iranian government hopes to eventually ramp up oil production to 2 million barrels a day. That would add an extra 2% to global supply based on data from 2014.
So who cares if oil is cheap? Well first of all, the countries that rely on oil exports as their primary source of revenue. In Saudi Arabia for example, 90% of government revenues come from oil sales. The Saudi government has been attempting to diversify its economy, but oil sales constitute 45% of GDP and 90% of export earnings. In order to balance its budget without raising taxes, Saudi Arabia must sell oil for at least $100 per barrel. That is a far cry from the price today. The Russian economy is also dependent on high oil prices. Oil makes up more than half the government’s budget as well as 70% of total exports. In 2014 Russia produced 10.9 million barrels of oil per day on average. By one estimate, for every dollar that the gas price falls, Russia loses two billion US dollars.
There are substantial political consequences that stem from low oil prices. Since the Arab Spring, Saudi Arabia has increased its social spending to maintain the country’s stability. If oil prices were to hover around $35/barrel for the foreseeable future, that could jeopardize the spending that the Saudi government feels is keeping the peace. Venezuela is also experiencing crushing losses from low oil prices. Some analysts suggest that the reason Cuba finally reached a deal with the U.S. after decades of animosity was that Venezuela could no longer aid Cuba economically with its own country in shambles. Cuba’s natural inclination was to turn to trade with the U.S.
Low oil prices are also aiding the international community in the fight against Islamic State (IS). By one 2014 estimate, IS was earning $1-$2,000,000 per day from selling oil. That figure is down to approximately $300,000 today in part because of low oil prices, making their global terror mission far more difficult to fund. This pressure could help hasten the downfall of IS.
Oil prices are a double-edged sword in terms of environmental concerns. People have been touting alternative clean energies for years as the future of energy. But as long as oil is a cheaper source of energy, it will power the world. The possible silver lining is that when oil prices eventually rebound, clean energy sources will have become so efficient out of the necessity of competition, that they will be truly viable.
Our world is as dependent on oil as I am dependent on jelly beans. Even small variations in this worldwide commodity make big waves. And dropping approximately 250% is no small variation. It is not clear how exactly oil prices will affect the world in the months to come. But it is a certainty that oil underpins geopolitical trends around the world.