Crude oil price a vic­tim of pol­i­tics

Financial Mirror (Cyprus) - - FRONT PAGE -

Oil pro­duc­tion has never been so po­lit­i­cal. If you’ve taken time out from Black Fri­day shop­ping to follow the mar­kets this week, you’ll know that the com­mod­ity’s price con­tin­ues to de­cline and cause con­tro­versy. The nor­mal eco­nomic prin­ci­ple of sup­ply and de­mand seems to have been flung out of the win­dow of the Mid­dle East: when the Or­gan­i­sa­tion of Pe­tro­leum Ex­port­ing Coun­tries (OPEC) met on Thurs­day, they didn’t agree to save prices and cut back pro­duc­tion.

On Wall recorded a

Street, six-week the S&P 500 long win­ning in­dex streak. That’s be­cause low oil prices di­rectly ben­e­fit air­lines and trans­port based in­dus­tries, and in­di­rectly mean that con­sumers have greater spend­ing power thanks to re­duced petrol costs. But we know that oil pro­duc­ers don’t care about our sav­ings at the pump! So, what are the real un­der­ly­ing mo­tives that have driven OPEC’s decision?

The fall­ing prices are a re­sult of the ex­pan­sion of the US frack­ing boom which has cre­ated a sur­plus of shale oil. In just months, a bar­rel of oil has dropped in price from over $100 to about $70. Yet, para­dox­i­cally, frack­ing is ex­pen­sive and the suc­cess of the in­dus­try may be its own down­fall. The process re­quires a cer­tain oil price to be fi­nan­cially vi­able and Amer­ica’s com­peti­tors are now ex­pos­ing that.

OPEC’s decision to main­tain sup­ply cer­tainly wasn’t unan­i­mous. Many mem­bers in­clud­ing Venezuela and Nige­ria cam­paigned to keep prices high. Th­ese coun­tries need lev­els over $100 per bar­rel to fund na­tional bud­gets. Yet Saudi Ara­bia, the group’s most pow­er­ful mem­ber and the world’s largest oil pro­ducer, has its own in­ter­ests at heart. It is will­ing to take the short-term hit of low prices in or­der to grow its mar­ket share long-term.

Saudi Ara­bia’s re­fusal to play nice doesn’t only serve to pres­sure the US into curb­ing shale pro­duc­tion. The Sunni Mus­lim coun­try is no friend of Shi’ite Iran, and it sees Rus­sia, like the US, as a ma­jor oil com­peti­tor. It knows that the economies of Iran and Rus­sia are al­ready weak from sanc­tions im­posed by the West, and are heav­ily de­pen­dent on oil. Ar­guably, they are at risk of to­tal col­lapse if the low oil price is sus­tained over a sig­nif­i­cant time.

The ques­tion for an­a­lysts is how main­tain­able th­ese low prices are. It is likely that the smaller frack­ing busi­nesses in the US will strug­gle, but the larger ones will sim­ply re­sume op­er­a­tions as prices rise, and may well adapt and be­come more cost-ef­fi­cient. In Rus­sia and Iran, oil pro­duc­tion may slow down but it is un­likely to grind to a halt de­spite the eco­nomic reper­cus­sions: low oil rev­enues still equate to more in­come than no rev­enues.

Saudi Ara­bia cer­tainly in­tends for other coun­tries to give way first, but there’s only so much pain that you can in­flict upon your­self. Re­al­is­ti­cally, if its tac­tics fail and prices re­main at the present lows, or sink lower, it would at some stage agree to cut pro­duc­tion along with other OPEC mem­bers be­fore it hurts it­self too much. All good things must come to an end – low oil prices in­cluded.

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