ENERGY by Peter WestmoreNews Weekly
The politics of falling oil prices
, December 20, 2014
After years of high oil prices driven by scarcity of oil and fears that oil is running out, the price of crude oil has fallen from about $US115 to less than $US70 a barrel over the past six months, causing a dramatic and welcome fall in the price of petrol at the bowser.
Crude oil prices: 1994-2014
What is going on?
The crude oil price is basically driven by supply and demand. For decades, the environmental movement has been insisting that fossil fuels, a non-renewable resource, are running out, and that the world is on the brink of acute shortages, if not the end of the petroleum era.
Contrary to this doomsday scenario, and despite the steady increase in oil consumption, new reserves of oil and gas are being discovered and, depending on cost, brought on line.
High prices for crude oil had the effect of encouraging further exploration and the expansion of production from fields which would otherwise be economically marginal.
These incentives have been spectacularly successful, particularly as a result of the expansion of oil and gas production from shale, using new extraction techniques.
Further, slowing economic growth in China and improved efficiencies in energy usage have led to reduced global demand for oil. These factors put downward pressure on oil prices. At this point, politics enters the equation.
Since the early 1970s, the price of crude oil has been controlled by the Organisation of Petroleum Exporting Countries (OPEC), the most successful cartel in the history of the world.
OPEC is dominated by Saudi Arabia, along with the oil-producing states of the Persian Gulf. Saudi Arabia could continue to supply oil profitably to the world at half today’s prices.
Saudi Arabia works with the United States, the world’s largest consumer of petroleum, to regulate the price of oil. This ensures that the oil-producing countries get a fair price for crude oil, but that oil prices do not rise in a way which would damage the world’s economy.
OPEC controls oil prices by imposing production quotas, which are designed to keep supply and demand in line.
If oil prices rise unexpectedly, the OPEC states increase production, thereby pushing prices down.
However, if oil prices start to fall, OPEC’s ability to cut production is limited by the fact that 60 per cent of the world’s production comes from countries outside OPEC, including the United States, the world’s largest consumer, and Russia, which is one of the world’s largest producers.
Russia has consistently refused to join OPEC, because it would have to accept OPEC’s rules to control production.
Saudi Arabia and other OPEC states believe that Russia and other non-OPEC states have exploited the organisation to extract good prices when supply is short, but refuse to accept OPEC’s discipline to limit supply when prices are falling.
Additionally, the Saudis are alarmed by the expansion of U.S. shale oil production, which is squeezing them out of the lucrative American market.
Over the past six months, as prices fell, OPEC responded by maintaining production, and called on the non-OPEC countries to curb their output as a condition for cuts by OPEC.
The effect of this has been to accelerate the decline in spot prices, to the point where some observers consider that crude oil prices could fall to $US50 a barrel. This has had a dramatic and damaging effect on some of the high-cost OPEC nations, on shale-oil producers, and on the non-OPEC oil-producers, particularly Russia.
Russia’s economy has already been severely hit by Western sanctions over Moscow’s annexation of Crimea and continued destabilisation of eastern Ukraine, whose territorial integrity it had promised to respect.
Now the sudden collapse of oil prices has plunged the Russian economy into recession. The Moscow stock market is in free-fall, as is the exchange rate for the Russian rouble.
A further issue is Russia’s support for Syria’s Assad regime.
The Saudis, who are Sunni Muslims, have been bankrolling the Sunni opposition to Syria’s Alawite Muslim leadership of Bashar al-Assad.
Moscow has been the principal international supporter of Assad and been crucial to supplying him with the weapons needed to defeat the Sunni insurgency.
Over time, the Syrian resistance has fallen increasingly under the control of Sunni terrorists, originally linked to al Qaeda, and more recently, to the Islamic State (IS), which has perpetrated genocide in the areas of Iraq and Syria that it controls, and executed Western captives by beheading.
This led the United States to send a multi-national force to degrade and destroy IS, indirectly assisting Assad to remain in power in Syria.
In summary, Saudi Arabia has three targets in the current oil price war: U.S. and Canadian shale-oil producers, which it wants to drive out of business; its rival states in the Middle East, including Iran, Iraq and Syria; and, finally, Russia.
The collapse in oil prices is driven by politics, not availability. It is unlikely to end any time soon.