How United States, OECD Nations Forced Fall In Oil Prices

Jonathan

 

 

By Eke Uchechukwu

 

  Oil is first and foremost a commodity. Besides being a commodity, oil also had been variously described as a weapon, a strategic asset, a curse and a maker and spoiler of fortunes. Crude oil prices like prices of other commodities are controlled by the forces of demand and supply. Thus  like other commodity markets, the crude oil market is cyclical with prices falling and rising in response to changes in demand as well as OPEC and non-OPEC supply. Such crude oil price cycles often vary from a week to several years. Currently global oil prices have been falling steadily since June 2014.  OPEC daily basket price for instance, declined by 54.4 per cent from $110.30 per barrel Monday, 23 June 2014 to $50.30 per barrel Monday, 23 March 2015.  This oil prices slump generally attributed to market oversupply arising from shale oil boom in the United States and OPEC’s uncharacteristic refusal to cut production is reversing the economic fortunes of oil exporting and importing nations. The falling crude oil prices have turned the economic stress which high oil prices imposed on oil import dependent nations led by the United States into economic fortune while turning the fortune of export dependent nations led by Russia into economic doom. Following the oil price crash, the economies of oil import dependent nations have been expanding accompanied by sharp growth in job placement. On the contrary, the economies of oil export dependent OPEC nations have been contracting, going through a period of local currency depreciation, high inflation and unemployment. It is therefore not surprising that oil import dependent nations who are benefiting from the low oil prices would want the situation to continue, while OPEC nations whose economies are undergoing sever stress, look up to a very quick price recovery. The question being asked is, how soon will global crude oil prices rebound? Any attempt at providing an answer to this question that focuses on the immediate roles of OPEC and the U.S in this oil price slump but ignores a critical review of the remote causes, will not suffice.

    The Organisation of Petroleum Exporting Countries (OPEC) came into existence in 1960, with the stated objective of promoting the economic interest of her members by ensuring that they get the right value for their oil. At least up to 1973 OPEC strictly pursued this economic objective without much success and without attracting much attention from the consuming nations. Prior to the formation of OPEC in 1960 and even up to 1970, ten years after coming into being, the control of oil prices lay with the Texas Railroads Commission. But from 1970 the ability of the United States to produce oil began to decline thus paving way for OPEC to take over the driver’s seat. Throughout the period the Texas Railroads Commission held sway, oil prices remained low and fairly stable around $3 dollars per barrel. In 1972 for instance oil price was $3.5 per barrel. But that was the last time oil could be so cheap. In 1973 when the members of the Organisation of Arab Petroleum Exporting Countries (OAPEC) who are also members of OPEC imposed an oil embargo on the United States and its allies for supporting Israel in the Yon Kippur war, the world became shockingly aware of the powerful geopolitical weapon that oil can be. By the end of 1974, average world crude oil price had spiked to $12 per barrel, inducing economic recession to the disadvantage of the United States and its allies. A consequence of the oil embargo which sounded the wakeup call on energy security of the OECD member nations was that OPEC as a whole had courted the anger of the U.S and Organisation for Economic Cooperation and Development (OECD) member nations.  Expectedly their reaction was very sharp and swift.  Realising that it had lost her capacity to control the oil market through production, the United States galvanized OECD member countries to square up with OPEC.  OPEC was therefore marked out as a cartel which must be destroyed at all cost, if the energy security of member nations was to be guaranteed. To coordinate member nations’ energy policies to mitigate the effect of the oil embargo and to prepare them for future oil supply disruptions, the OECD in 1974 established the International Energy Agency (IEA). The OECD felt that a coordinated response would prove more effective than allowing individual nations ‘go-it-alone’. With the formation of IEA, the world was effectively divided into three major energy market players, OPEC, OECD and the ROW (rest of the world). It also marked the beginning of the energy chess game between OPEC and OECD in which the ROW is the umpire.

  In carrying out its mandate, the IEA formulated an emergency response strategy which focused on four supply and demand side countermeasures. On the supply side the strategy involved member nations implementing a strategic Petroleum Reserve capable of holding equivalent of at least 90 days stocks. The other supply side measure required member nations to increase domestic  production  of  oil.  On the demand side  the  counter measures formulated required OECD member nations to implement energy conservation and efficiency as well as pursue the development of alternative fuels. The pursuit of the objectives of the IEA countermeasure spurred three kinds of energy  revolutions;  a  renewable  energy  revolution  aimed  at  increasing  the  development  and  deployment  of renewable energy from solar, hydro, wind, geothermal, and bio-energy sources; energy efficiency revolution aimed at achieving energy conservation; and shale oil  and gas and other unconventional oil  and gas revolution aimed at increasing the production of oil and gas from shale and tar sand. As a result of the renewable energy and energy efficiency revolutions in OECD nations and adopted by other countries, the share of oil in total energy consumption in OECD for instance declined by 15 per cent from 46 per cent in 1973 to 31 per cent by 2012 and is still falling.

 As the U.S, pursued her shale oil project, her neighbour Canada was working on the development of her unconventional oil from tar sand. Unarguably the current global slump in oil prices is not a chance event but is the outcome of the menu of deliberate countermeasures implemented by OECD member nations since the 1973/74 oil crisis.  Renewable and energy efficiency programmes and increased unconventional oil  and gas production from shale in the U.S and oil sands in Canada have combined to radically alter the global energy market landscape and whittled down the capacity of OPEC to influence the oil market.  Any wonder OPEC is in disarray. For the   first time OPEC cannot fight back by controlling supply. Rather she is allowing market forces to play out, an indication of loss of control. The reality is that the organisation cannot do otherwise, since it has also lost its dominant share of world oil production. OPEC’s share of global oil production had declined by 9 per cent, from 52 per cent in 1973 to 43per cent in 2012 while production in OECD is increasing, with the United States of America becoming the world’s largest oil and gas producer in 2014 after overtaking Saudi Arabia and Russia.

 OPEC by allowing market forces to resolve the slump in oil prices is hoping that oil prices will rebound when higher cost shale oil producing companies in the U.S hurting from low returns are forced to cut production. In reality companies in OPEC nations are producing at a lower cost than shale oil and tar sand oil producers in the U.S and Canada who are therefore impacted more by the effect of falling oil prices. Declining rig count statistics in the U.S may be a sign that companies are holding back on new shale field development. But even at that production from already drilled wells will take some time to stop. It remains to be seen however, how the U.S will allow control slip from her so easily after working so hard in the last 41 years to extricate herself from the stranglehold of OPEC and having succeeded not only in doing so but also in taking over the control of the market the Texas Railroads Commission lost to OPEC in 1972. It is very doubtful that the U.S will so miss this opportunity of seeing OPEC pay for the economic pain inflicted on her and the OECD during the 1973/74 oil crisis and ever since. Rather it seem plausible that the U.S government may have to do whatever it will take to cushion the impact of low return for oil companies while she watches OPEC in pains for as long time as possible. The IEA has predicted that the influence of the U.S shale oil production on the global oil market will not wane before the year 2020 and that OPEC will return to her preeminent position as the world’s major supplier after that year. From now to the year 2020 will imply five good years of economic strangulation for oil export dependent OPEC member nations if oil prices do not rebound.  It is therefore imperative that OPEC countries hurting from declining oil revenue need not wait till 2020 to react, otherwise there will be no OPEC by then as members would have left  to design their individual optimal marketing strategies. Should OPEC disintegrate, the OECD would have succeeded in killing two birds with one stone. Whether OPEC continues to adopt the ‘do-nothing approach’ or decides to do something, what is certain is that the world is in for a long low oil prices regime that will last beyond 2015.

  OPEC member nations must wake up to the above reality,  that this price slump is different from others previously and that their competitors the OECD are now in control. Like the OECD in 1973/74 OPEC should move quickly  to  fashion out  measures to mitigate the  impact  of  this  deadly  oil  prices slump on their  economies and currencies. The OECD may have called on their technological ingenuity to overcome their energy supply problem that has created the present problem for  OPEC, OPEC on the  other  hand is  not  technologically endowed and therefore must look inwards at their economic management systems for solution.  Member nations must seize this opportunity to aggressively implement the three D strategy of Diversification, Deregulation and Discipline. There is no better  time  than now to  vigorously  embrace  economic  deregulation,  oil  and gas  sector  deregulation  and fiscal discipline in OPEC member nations.