For the first time in five years, one can buy a metaphorical barrel of crude oil – variant on the extraction point – for below $60. The price has been dropping steadily over the last six months. but analyst have been surprised at how swiftly this has picked up in the last week. As recently as mid-June, Brent crude, a typical benchmark measure based on light oil from the North Sea, was priced as high as $115; it dropped to $70 at the end of November and is falling towards $60. With the Organisation of Petroleum Exporting Countries (OPEC) failing to agree a supply cut, and bodies such as the International Energy Agency (IEA) publishing forecasts suggesting further falling global demand, the prospects do not look fruitful for oil companies. nor those rentier economies whose health relies on demand for oil resources. But why has the price of oil fallen so suddenly, after so long at relatively high prices? And what does this mean for the stock market and, perhaps more importantly, the consumer?
The causes of the initial fall in prices are somewhat opaque, but they include, as a primary node, the logical general decrease in demand for oil in itself. This is usually the cause of some other phenomenon, such as a strong dollar, which certainly could be pointed to in this case. However, it does seem that alternative forms of energy demand, such as shale and gas, have reduced the consumer dependency on oil that has kept prices so high for so long.
The significant fall in price has highlighted the complexities of the global oil markets, and the increasing rift between the interests of OPEC and other oil producers. OPEC, which consists of the Arab Gulf states, Iran, Iraq, Ecuador, Venezuela and some African exporters, and controls oil production levels in its member economies, had the chance to lower production quotas this month; by economic theory, to reduce supply and thus increase price to maintain long term revenues for exporters. OPEC quotas have caused more than just price drops or petty scandal before; the first Gulf War in the early 1990s was effectively the cause of Kuwait flouting their OPEC quota, releasing excess supply into the market and prompting Saddam Hussein’s Iraq to invade to keep production down.
There was distinct opposition to lowering production this time, however, particularly from the Saudis, whose tactics are taking an interesting turn. Firstly, the more production, and the lower the cost of production, an economy maintains, the lower the effects of a price drop. Whereas US oil producers require a high price per barrel of oil to break even, those in the Arabian Peninsula in particular have significantly lower costs and thus can make do with a lower price (the US recently overtook Saudi Arabia as the world’s top oil producer). The Saudis, then, could be said to be pushing the Americans in a price war more commonly seen on the shelves of supermarkets than in the oil markets. Hopefully, with the standard rules of the free market becoming more apparent, this will return power to those countries whose consumption of oil exceeds their production, including the UK.
Secondly, in turn, Saudi Arabia, in particular, has revealed its somewhat original attitude to oil economics. The apparent scarcity of the commodity generally leads oil prices to be arbitrarily high, giving oil companies especially inflated levels of economic power: four of the ten most valuable companies in 2012 were oil and gas producers (ExxonMobil, PetroChina, Royal Dutch Shell and Chevron) not including those that are not publicly traded, such as Saudi Aramco, widely believed to be the world economy’s most valuable corporation; 21 of the world’s largest firms by consolidated revenue are oil and gas producers, including six of the top seven (the aforementioned firms plus Sinopec and BP). The Saudis, however, seem to be suggesting that they are working with oil as an infinite resource, or at least, not governed by the rules adhered to for so many years previously. This leaves little regard for prices, and may in fact encourage the Saudis to increase production.
Thirdly, again in turn, this reveals that the Saudis care more about market share, particularly vis-à-vis the Americans, who match if not exceed on production but export very little of their oil, and other OPEC members, than they do about revenue. The political condition of Saudi Arabia may explain this. On the one hand, Saudi Arabia houses the largest known oil reserves on the planet, which may encourage oil minister Ali Al-Naim to treat his stocks more liberally than expected. On another, the very existence of the Saudi state, and the political health of the royal family, relies more on oil than is perhaps advisable. Thus, a cut in production and potential loss of market share, which in itself could lead to dangerously low revenues in the long run, could mean far more for the Saudis than for most oil-dependent governments. Given the comparable lack of unrest in Riyadh compared to other Arab states such as Bahrain, Egypt and Syria since 2011, it could also be suggested that a loss in short term revenue for the provision of longer term health is not too much of a big deal.
After OPEC decided not to lower production, and the IEA forecasted a fall in demand for the coming year, oil prices do not look set to rise with any force any time soon. How, therefore, will this affect the stock market? The price of stocks in the big, public oil firms naturally fell this week, some by a couple of percentage points in a single day. Elsewhere, however, there is scope for growth, most prominently in those industries and sectors whose many costs are contributed to by the price of oil. Airline stocks, for instance, rose noticeably this week, and consumer spending, influenced predominately by the fluctuation in the cost of living, in turn fundamentally affected on many levels by the price of oil, has risen and is expected to rise further. This gives premise for growth in retail stocks too.
It will surely, given the Saudi’s stubborn position on the matter, be a case of protest by the smaller producers that will change something up. It can only be a matter of time, and the price of crude oil can only fall so low, before exporters such as Bahrain and Qatar, who rely so dangerously on revenues from oil (potentially to the extent that income tax is unnecessary, thus removing citizens/subjects from the political process and contributing further to unrest) have to inject some form of change into the market in order to maintain government. Despite this, the market should not forget that, despite the huge Saudi stocks and general prominence of oil in the world economy, that oil remains a finite resource, and should be slowly replaced as an energy source. This website has published previously on energy consumption, and advocates the further development of renewable energy as a viable source: http://wp.me/p3g0mz-1u).