PRICE OF CRUDE OIL AND POLITICS BY Dr. BOBBY SRINIVASAN AND Dr. SUDHAKAR BALACHANDRAN

October 28, 2014 | Posted by bobbysrinivasan << back to blog

Historically, whenever there is a geo-political crisis in the world, its impact will be felt on the oil prices. For example, during the Iran-Iraq war of attrition oil prices reached new highs. The traders and speculators pushed the oil prices up to 146 dollars a barrel in the past. Now the world has a plethora of political problems and the oil price is coming down rapidly. Let us understand the geo-political situation first.
The Islamic state of Iraq and Levant (ISIS) has seized large territories both in Syria and Iraq. An undeclared war has broken between Russia and Ukraine. There have been seriously damaging conflicts between the Palestinians and the Israelis in the Gaza territory. Libya is in a state of chaos. Uncertainty hangs over nuclear negotiations with Iran.
These are possible risk situations which should have pushed up the oil prices. Surprisingly, it is not happening. One of the possible reasons could be the resurgence of North American supply. One of the global energy experts Daniel Yergin made the following comment:
“while there may be a surplus of geopolitical risk in the world, there is an even greater surplus of oil.”
Let us look at facts. The US crude oil output is up almost 80% since 2008, supplying an extra 3.9 million barrels a day, more than what is produces by any of OPEC’s 12 members except Saudi Arabia. To top it off, Canadian tar sands have added another 1 million barrels. Normally, this excess supply would have been absorbed by the market but for the weakening demand in emerging markets. This has created severe mismatch between demand and supply. It is also believed that the demand may fall further by the end of the year.
The surging production in North America has basically offset the drop in production in Iran due to international sanctions, Libya, Nigeria and Sudan among others. Libya in spite of its internal problem has managed to quadruple its output at a time when the market is weakening.
The question now is how low can oil prices go? Currently, brent crude is trading around 85 dollars. The answer is that the US is holding the key. Studies show that even at $75 a barrel, it is still economical for the US to supply. Further drop in oil prices will create a stream of action from the OPEC. Everyone will try to gain the market share when the others are cutting the supply to the market. The OPEC itself may face challenges regarding the quota to be allotted to each of its members. Saudi Arabia is sitting pretty with 800 billion foreign reserves and so they have the staying power to endure the price drop. The next OPEC meeting is on November 27, 2014. Nobody is certain about its outcome. We need to wait and see.
Now the question is who is happy with the oil price drop? India, of course, is mighty happy. Their budget deficit has a possibility of coming down with the withdrawal of deficits. Their trade deficit will come down significantly as it spends $160 billion every year on the net oil imports.
The US citizens will be happy also. At $80 a barrel (instead of $110 as before), they would have an extra $160 billion in their pockets (similar to a big tax cut). Japan will be happy because they entirely depend on foreign oil. China imports 60% of its oil requirements and so is a beneficiary.
Russia, on the other hand, is highly dependent on oil revenue. More than 40% of state budget comes from oil. Lower prices will hurt the Russian economy which is already closer to recession and this will only worsen the situation.
Globally, it is a good news. Inflation due to oil prices will disappear. Commodity prices may head lower. The fear of oil shortage will disappear. But the deflationary trend in the global economic scenario (Eurozone and japan) portends bad things to come. Let us wait and watch.

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