The price of oil is down. How should we expect the economy to perform in 2015 and 2016? If our only problem was high oil prices, then low oil prices would seem to be a solution. Unfortunately, the problem we are encountering now is extremely low prices. If prices continue at this low level we are in deep trouble with respect to future oil extraction. We may be reaching limits of a finite world.
The Nature of Our Problem with Oil Prices:
The low oil prices we are seeing are symptoms of serious problems within the economy–called “increased inefficiency” (really diminishing returns) –leading to low wages. While wages have been stagnating, the cost of oil extraction has been increasing by about ten percent a year. Needless to say, stagnating wages together with rapidly rising costs of oil production leads to a mismatch between: the amount consumers can afford for oil and the cost of oil, if oil price matches the cost of production.
OPEC on the Oil Crisis:
OPEC is a collection of oil-producing nations that pumps out about 40 percent of the world’s oil. In the past, this cartel has sometimes tried to influence the price of oil by coordinating either to cut back or boost production.
At its big meeting in Vienna on November 27, there was a lot of heated debate among OPEC members about how best to respond to the drop in oil prices. Some countries, like Venezuela and Iran, wanted the cartel (mainly Saudi Arabia) to cut back on production in order to prop up the price. These countries need high prices in order to “break even” on their budgets and pay for all the government spending they’ve racked up. On the other side of the debate was Saudi Arabia, the world’s second-largest crude oil producer, which was opposed to cutting production and seemed willing to let prices keep dropping.
In the end, OPEC couldn’t quite agree on a response and ended up keeping production unchanged. That caused the price of oil to start crashing even further. The price of Brent crude went from $80 per barrel to $50 by January.
Curbing the Menace:
The continuous falling rates have resulted in a situation called peak oil. Peak oil, is the point in time when the maximum rate of extraction of petroleum is reached, after which the rate of production is expected to enter terminal decline. This created the need to look for other unconventional sources of oil such as oil shale. Shale oil extraction is an industrial process for unconventional oil production. This process converts kerogen into shale oil. The resultant shale oil is used as fuel oil or upgraded to meet refinery feedstock specifications by adding hydrogen and removing sulfur and nitrogen impurities.
The Crisis Worldwide: The plunge in oil prices is having significant economic consequences around the world.
Russia: Russia the world’s largest crude oil producer is hugely dependent on oil and gas production — with oil revenues making up 45 percent of the government budget — and the sharp fall on prices has been ruinous. Economists now estimate that Russia’s GDP will shrink at least 4.5 percent in 2015 if oil says below $60 per barrel. The plunging price of oil has also caused the ruble’s value to collapse — which is leading to panic inside Russia and a rise in inflation, as imports become drastically more expensive. Many Russians, worried that their savings may vanish, have been rushing out to buy cars and washing machines — anything that has more lasting value than currency.
So far, Russia’s central bank has been struggling to deal with this crisis. On December 15, 2014, the country suddenly hiked interest rates from 10.5 percent to 17 percent in an attempt to stop people from selling off rubles. But those rate hikes are likely to slow the country’s economy down even further.
Saudi Arabia: There’s no question that Saudi Arabia, the world’s second-largest crude producer, will suffer financially from cheap oil. If oil stays at around $60 per barrel even in 2015, the government will run a deficit equal to 14 percent of GDP. For now, however, the Saudis are toughing this out — and show no sign of trying to prop up prices as they have in the past. The kingdom has built up a stockpile of foreign currency worth some $750 billion, which it will use to finance its deficits.
In December, the country’s oil minister, Ali al-Naimi, said he didn’t care if prices crashed to $20 or $40 per barrel, he wasn’t going to budge from his position. “It is not in the interest of OPEC producers to cut their production, whatever the price is,” he said.
The United States:In the US, meanwhile, a fall in crude prices will have both positive and negative impacts. For many people, it will offer an excellent economic boost: cheaper oil means lower gasoline prices — which have fallen to $2.04 per gallon, the lowest since 2009. That will give consumers more money to spend on other things.
But it’s not all good news. Oil-producing states like Texas and North Dakota are likely to see a drop in revenues and economic activity. The falling price of oil is also putting severe pressure on Alaska’s state budget. If the price drop lasts a long time, that could also spur people to start using more oil. Case in point: In recent years, high gasoline prices have spurred many Americans to buy smaller, more efficient cars. But if gasoline prices fall, bigger cars and SUVs could make a comeback. That said, overall US fuel economy will still keep rising over time — because the federal government has imposed new standards on cars and light trucks through 2025. But this might now happen more slowly.
China: China’s need for energy is growing faster than any other country. The air in major Chinese cities is approaching lethality. Most rivers are cesspools, tap water is undrinkable, and dangerous metals are building up in agricultural soil and starting to make their way into the food chain and to top it all off nobody really gets to vote for leaders or on policy.
Unregulated off-the-books “shadow banking” which has doubled in the last three years is now thought to total some $6 trillion. Government officials are concerned that it is out of control. The impact on the global oil market of efforts to control pollution and unwind excessive debt could be considerable. Until recently China’s demand for oil was increasing indefinitely, surpassing US oil consumption by the end of the decade and buying up all the oil OPEC and other exporters can produce soon thereafter. While chaos in the Middle East is threatening to curtail oil supplies from the region, the end of rapid growth in China is threatening to restrain a major source of increasing demand for oil.
Iran:Iran’s economy had recently started to rebound after years of recession. The International Monetary Fund had been projecting that the country was on track to grow 2.3 percent next year. But that was all before oil prices started to plunge — a potentially precarious situation for the country.
One big problem for Iran is that it also needs oil prices well north of $100 per barrel to balance its budget, especially since Western sanctions have made it much harder to export crude. If oil prices keep falling, the Iranian government may need to make up revenues elsewhere — say, by paring back domestic fuel subsidies (always an unpopular move, at least in the short term).
Venezuela:There’s growing concern that the oil crash could cause Venezuela, another major oil producer, to default. The nation’s economy — heavily dependent on oil revenue — is set to shrink some 3 percent this year and inflation is rampant.
Australia: The shock from soaring oil prices would also undermine the emerging hopes for a global economic recovery and depressing the terms of trade for oil-importing nations. The Australian government is as politically exposed to a new oil crisis as is the Obama administration. It will put increasing pressure on the cost of living.
Australia is far more vulnerable to an oil crisis than the level of direct imports from the Middle East would suggest. Australia’s oil refineries, which still supply 70 per cent of domestic petroleum products, depend on the Middle East for barely 15 per cent of their crude oil supplies.
Conclusion on the menace:
It is, at times, hard to believe that there really is a “peak oil crisis” lurking out there waiting to engulf our civilization and wreak havoc. Nearly every day now, oil and gasoline prices are falling. In fact we probably are already in a crisis but fail to recognize it for what it is.
While the financial press continues to chatter endlessly about the technological breakthroughs that have brought us millions of barrels of new shale oil, sadly they have the basics of the story wrong. It is the high prices that “oil” has been selling for in the last ten years, not the decades-old fracking technology that has allowed very expensive shale oil to be produced at such a scale. The question is just how much of our oil supply is in danger of being mothballed until prices climb again as they surely will. Until most of the World’s population is well informed on the damages and effects of oil I do not believe that we will be prompted to change our habits. This will lead to our own demise unless we come together and force change upon ourselves.