Over a barrel: Why low prices are bad for everyone

The collapse in crude oil prices will blow the bottom out of the shale oil business. Source: Shutterstock

The collapse in crude oil prices will blow the bottom out of the shale oil business. Source: Shutterstock

When oil prices dive it looks a lot better before it gets a lot worse. The US and its sidekick Saudi Arabia will learn that bitter lesson soon enough.

Everyone knows high oil prices are bad for your pocket and hurt the global economy. But did you know that low oil prices are just as harmful? Sure, paying less at the pump feels good but a prolonged spell of low oil prices hits your wallet in a significant way. Here’s how it works.

First up, oil producing and exporting countries are consumers too. They buy a ton of products – from household to luxury and from commercial to industrial. When oil prices go down, oil exporters are forced to tighten their belts and cut down the import of these items.

Big oil consumers – that produce little or no oil – include Japan, India and Germany. Oil prices have plunged from over $100 a barrel in September to under $80 in November, presenting a windfall for such importers.

Now what happens to large exporters? The Russian economy, for instance, is clearly hurting. The upshot: middle class Russians will have less money to spend on Toyotas and Volkswagens. Plus, Russian companies will buy less engineering equipment from Germany and Japan. Similarly, the UAE – India’s largest export market – will import less food from India.

The oil industry is just like any other industry, where producers want fair prices in order to sustain wages and earn a decent profit. There is a goldilocks zone where prices need to remain so both producers and consumers think they are getting a fair deal. If it goes too high or too low, then everyone hurts.

But not everyone understands such basic economics. The current collapse is the handiwork of Saudi Arabia, which believes it can generate a – marginal – profit even at current low prices. First, it is flooding the market with millions of extra barrels of crude daily. And to ensure that prices plunge, the Saudis are cutting prices to American buyers.

The aim is to hurt Russia and Iran – the two counties that together pushed back the Saudi-Qatar financed Islamic State terrorists, and continue to support Syrian President Bashar al-Assad.

Now Saudi Arabia may nurse a grievance against Moscow and Tehran but the royals can’t move a tissue within their bodies without the permission of their American controllers. The US has half a million troops in the Middle East and is sworn to ensure the security of the highly unpopular Saudi royal family. The Saudis are pumping out oil like there’s no tomorrow because the Americans have ordered them to.

It is a game of you scratch my back, I scratch yours. The US has an agreement with the Saudis that the kingdom can only accept US dollars for their oil. Because crude oil is the largest traded commodity in the world, it makes the dollar the default international currency, directly benefitting the American economy. Also, all the Gulf sheikdoms invest their oil income predominantly in US banks. In exchange, the US guarantees the safety of these undemocratic and barbaric regimes.

The way the Saudis see it, they can suffer low oil prices longer than Russia or Iran. The sheiks believe they can squeeze the Russians and Iranians long enough to make them hand over their ally Assad.

But while the Saudis may have deep pockets, they are not smart enough. For, those pockets are not deep enough to sustain a long-term price war. For, they produce nothing else other than black gold, but at the same time have to maintain the massive subsidies that keep their princelings and masses distracted. (Some believe there are as many as 100,000 of these royals whose extravagant lifestyles are a huge burden on Riyadh)

On the other hand, both Russia and Iran have a high threshold for pain. Russia is also not entirely dependent on oil income. Bottom line: if oil prices don’t climb back to at least $90, heads will roll in Saudi Arabia.

What about the United States? Riding the shale gas boom, the US this year overtook Russia to become the largest energy producer on the planet. Largest doesn’t mean smartest: Washington seems to have misjudged the costs and consequences of the oil price war against Russia.

American companies have invested billions of dollars in shale gas projects across the country. Shale gas is a difficult resource to extract and involves fracking – or the use of as many 500 separate chemicals and huge amounts of water to extract gas trapped between layers of rock deep below the earth. It is not only expensive but the process has been proven to degrade the environment, especially ground water resources, pretty quickly.

However, Washington has ignored all perils and sanctioned hundreds of shale gas projects. The results have been nothing less than stunning. Until recently, the United States was the world’s largest oil importer; post-fracking it is largely energy independent.

But here’s the rub: the collapse in crude oil prices will blow the bottom out of the shale oil business. Because development costs are high, shale gas is viable only when crude oil prices remain high. Now with prices hitting rock bottom some shale fields are going to become unviable, and their producers are going to go under.

If shale gas production collapses, the United States’ era of energy independence is going to be an extremely short one. And prices will once again start rising.

Meanwhile, here’s a reality check. In its latest annual World Energy Outlook, the International Energy Agency (IEA) says the current period of oil abundance may be temporary. Without high levels of production, oil markets will grow dangerously tight in the coming years, it says.

Global oil demand will increase by 37 per cent by 2040, with a dominant proportion of that coming from countries such as China and India. The IEA says that for every barrel of oil the industrialised world expects to eliminate from demand through efficiency or other ways of reducing demand, developing countries will burn through two additional barrels.

Endgame

World War II was mainly a fight over resources. Japan was forced to strike at the west after the United States imposed sanctions on it. Similarly, Germany felt its oil supplies were under threat from the British. We know what happened next.

No country will sit idle while sanctions hollow out its industry and economic vitality. Russia may well weather the double whammy of economic sanctions and low oil prices because it has a safety valve in the BRICS market. But if it feels the US is going all out to destroy its economy and markets, there could be a fierce counter-strike.

Clearly, with their judgement clouded by their desire to hurt Russia, somebody in the US State Department did not do their homework very well. As they say, those whom the gods want to destroy, they drive mad first.

All rights reserved by Rossiyskaya Gazeta.

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