Oil Price Slump is a Lose-Lose Situation

21.12.2015

The current oil price slump is different from that in the 1980s due to depletion of resources. The amount of cheap oil is reducing.

Last week oil prices slumped to a near seven-year low with Brent trading below $40 per barrel. Lower oil prices jeopardize energy exporting countries, but do not seem to help the consumer states either, experts interviewed by Valdaiclub.com believe.

Danila Bochkarev, a Brussels-based fellow of the EastWest Institute, believes the current oil prices are a consequence of the price war between traditional and new producers coupled with Iran’s return to the international oil market.

“The origin of the current fall in oil prices is the war which certain oil producers, like Saudi Arabia, are waging on newcomers. Over the past 7-8 years most investment went into unconventional oil, like shale oil in the US and Canada or in the deep offshore”, Bochkarev said.

According to Leonid Grigoryev, Adviser to Director General of the Analytical Center for the Government of the Russian Federation, oil was overpriced in the recent years. “Oil prices should have been at the level of $70-90 per barrel,” he said adding that the extra $20 was a political premium over Fukushima and Libya. “Had the world oil market functioned according to an economics textbook, the equilibrium price of oil would have been about $70 per barrel,” Grigoryev added.

The reason why oil production does not decline is the exporting countries’ urge to keep their contracts, Grigoryev went on to say. “Production cannot be lowered,” he added. “The growth of production and consumption will continue”.

He was echoed by Bochkarev who said countries like Saudi Arabia realize they have no alternative to oil, therefore it is vital for them to keep the existing contracts. “They are ready for budgetary losses and for oil at $20-30 per barrel,” the expert said.

According to Bochkarev, Saudi Arabia is different from other Gulf countries like Qatar and Kuwait, which are immune to low oil prices, as their population is much smaller and their per capita oil production is quite high. “While Saudi Arabia is the world’s biggest oil producer and exporter, they have already registered a 20% budget deficit, so in four or five years all their foreign currency reserves will run out. At this oil price they cannot keep their high living standards for more than three years,” he pointed out.

The current fall in oil prices ushers in an era of economic hardship for the exporting counties with a high population, Grigoryev said. “Russia faces serious problems, but countries like Indonesia, Nigeria, or Venezuela will be hit harder,” he added.

Last week, socialists lost a midterm parliamentary election in Venezuela, a development which can herald the end of their 16-year rule. After years of oil bonanza, Venezuela faced widespread poverty and turned out to be unable to maintain its generous social programmes.

Azerbaijan, which relies on energy for 70% of its income and 95% of its exports, could be the next country to face economic and social difficulties, Bochkarev said. It remains to be seen whether this will result in political unrest, as in Azerbaijan the government has a much stronger foothold compared to Venezuela, he added.

The importing countries might seem to be on the winning side, but this is only true for the energy-intensive industries, like transport and chemicals, while oil companies are losing revenues, Grigoryev said.

In Russia, oil companies are losing their revenues not as dramatically as the national budget, Bochkarev said. “There, the oil export duty is pegged to the oil price. For instance, in December 2015 the oil export duty was lowered to $88.4 per tonne or around $12.5 per barrel. At below $27 per barrel the duty is not charged at all,” he explained.

According to Bochkarev, the low oil prices create a “lose-lose situation”. “Saudi Arabia is trying to keep its market share, but its income has gone terribly down,” he said. “The US is in an ambiguous situation: while the consumers enjoy cheap gasoline, the producers are suffering. There are a lot of negative implications for the renewables: with oil at $30-40 there are very few incentives to invest in them.”

The current oil price slump is different from that in the 1980s, Bochkarev said, due to depletion of resources. “At that time, we had a lot of oil in the Soviet Union and the Gulf, which was cheap to produce. Now the amount of cheap oil is reducing. If in theory this situation lasts for 3-5 years, we will see a dramatic drop in oil production,” he said.

Therefore, the need to develop alternative energy sources remains relevant in the long term. “Although experts worldwide say we can for some time forget about investment in unconventional oil, as well as deep offshore, the Arctic etc., oil will eventually be replaced, in a matter of 50-80 years,” Bochkarev concluded.
Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.

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