In recent weeks, Saudi Arabia, OPEC’s largest oil producer, took two extraordinary steps to maintain its market share.
These measures have helped triggered a near free-fall in the oil market, with prices hitting their lowest levels in more than five years and with no bottom in sight.
The repercussions of this oil price shock will be widespread, and could become quite serious.
At a Nov. 27 meeting, Saudi Arabia pushed the OPEC group to keep its production target unchanged, at 30 million barrels a day. What OPEC does has huge influence on the market, because its production represents close to one-third of global output.
Then the state-owned Saudi Arabian Oil Co. reduced its official selling prices January for all oil grades bound for Asia by $1.50 to $1.90 a barrel. It also dropped its January prices for all crude grades to the U.S. by 10 to 90 cents a barrel.
This represents a bit of a U-turn for the Saudis.
Until recently, the country had considered a Venezuelan proposal to cut OPEC’s oil output by two million barrels to counter falling demand and support prices. But that plan faltered when Russia refused to cut its production.
Saudi Arabia feels threatened by soaring oil production from American shale fields. U.S. production of crude oil, along with liquids separated from natural gas, surpassed all other countries this year, with daily output exceeding 11 million barrels. And U.S. oil production could increase in 2015, despite OPEC’s efforts to restrain American shale producers. Its low prices are hoped to make U.S. shale oil uneconomic. They also hurt Saudi Arabia’s opponent, Iran.
With new technologies, analysts expect that the U.S. will continue to drill the most efficient wells. In the three geologic formations that account for 88 percent of U.S. shale oil output — the Bakken in North Dakota and the Eagle Ford and Permian in Texas — companies can drill new wells profitably even if crude fell to $25 a barrel, according to a team of analysts led by Manuj Nikhanj at ITG Investment Research Inc.
The fallout from the precipitous decline in oil prices can cause widespread problems for energy producers. Saudi Arabia uses its oil revenues to support its entire economy, and its budget requires oil to sell for $90 a barrel to break even. Other OPEC members have even higher budgetary break-even points.
Russia is especially vulnerable to low petroleum prices, since energy exports make up half of its budget. After months of insisting that Russia could withstand sanctions and plunging oil prices, Moscow recently acknowledged that the economy would fall into a recession next year.
Venezuela and Nigeria are likely to experience even more domestic troubles than they already have because they can no longer afford their welfare programs.
Most economists project that cheaper oil will stimulate the world’s economy and be especially helpful to countries with high energy tabs. A fall in oil prices is effectively a free tax cut and/or subsidy. It gives consumers more money to spend on food, clothing and housing. At $60 per barrel, the annual saving per American family approaches $3,000.
But pessimists counter that the dramatic decline in oil prices might be a canary-in-the-coal-mine warning, even for countries that are less dependent on oil income. The poison-gas threat in this situation is deflation.
Monetary authorities in Europe and America aim for 2 percent inflation. But Europe’s inflation rate is only 0.4 percent. In the eurozone, 31 percent of goods are now falling in price.
Falling prices, while they might seem like a good thing, can cause serious macro-economic problems, including lower consumer spending and reduced business investment.
And if advanced economies enter deflation, it could prove very difficult for them to escape. Deflation can lead to long periods of stagnant growth, such as Japan’s lost decade.
But deflation could prove to be a gentle result compared with the cataclysms that could overtake individual vulnerable countries and regions.
Originally published in the Sarasota Herald-Tribune
