Question:
Some media outlets reported today, Wednesday, January 7, 2015, that Brent crude prices reached $49.66 per barrel, while US crude fell to about $47 per barrel. It is noteworthy that oil prices in 2014 had reached $115 per barrel at the beginning of the summer in June 2014, then began to decline gradually until they reached $60 at the beginning of winter in late December 2014, and even lower, as West Texas Intermediate (WTI) prices reached $58.53. Now, in the first week of January 2015, it has reached about $50—representing a drop of more than 50% in approximately five months! What are the reasons for this sudden drop in oil prices? And what is expected for oil prices in the future?
Answer:
The decline in oil prices has various causes, most notably purely economic factors independent of political motives... and political factors that manipulate economic variables to serve the interests of the political actor...
As for the economic factor independent of political purpose, it includes: (an increase in oil supply or a decrease in demand...), (tensions, especially military flare-ups in and around oil-producing regions...), (speculation in the oil market and exploiting data regarding the economic weakness of influential oil-exporting or oil-importing countries...).
As for the political factor used to move economic variables toward the interest of the state behind the political action, it includes things like (increasing production or offering large quantities of oil reserves, but not for an economic need), but rather (to lower the price to influence the policy of competing countries, especially those whose budgets depend on oil prices), or (to limit the production of shale oil by lowering the price of conventional oil to a level below the cost of shale oil, making its extraction non-viable).
We will review these matters and then conclude with the most likely reasons for the significant reduction in oil prices:
First: Economic Factors Independent of Political Purpose:
1. Supply and Demand:
Oil, like any other commodity, has its price determined by supply and demand. When the oil market experiences a surplus in supply, the price drops. This happens during economic crises in importing countries, where demand decreases because the crisis-stricken country's ability to import oil at high prices diminishes; thus, demand falls, leading to a price drop... Similarly, when demand for oil intensifies and exceeds supply, its price rises.
2. Tensions and Military Flare-ups:
There is another factor that affects oil prices, which is "anticipation," i.e., market expectations, such as a potential disruption in supplies due to wars or tensions in oil regions... Therefore, geopolitical tensions in the Middle East, where oil regions are located, can be a reason for rising oil prices despite no actual change in the quantity of supply or demand. The oil market may push prices higher if there is a fear of potential supply disruptions. When tensions subside, the price of oil drops and returns to its previous value or real price. For example, the war rhetoric between the Jewish entity, the United States, and Iran in February 2012 led to an increase in oil prices. Forbes magazine stated: "With oil prices rising to their highest levels in several years, a large part of it is due to geopolitical fears, placing Iran on the military conflict table once again." ["Attacking Iran would push the United States into recession," Forbes, February 2012].
3. Speculation and Exploiting Economic Data:
Bad economic data from certain countries that significantly influence oil, whether as exporters or importers—such as the United States and China—can lead to a drop in oil prices regardless of changes in supply or demand. In this case, the market fears a slowdown in economic output and interprets it as an inevitable decline in oil consumption, causing the price to fall. Speculators hunt for market expectations to raise or lower oil prices to gain profits; as a result, the price of oil is affected beyond just supply and demand.
Economic data and speculation involve a number of key players: oil-producing countries (such as Russia, Canada, Saudi Arabia... etc.), oil-importing countries (such as China, Japan... etc.), multinational oil companies (such as Exxon Mobil, BP... etc.), the oil cartel (such as OPEC), and oil traders known as speculators. Each group has the ability to influence oil prices, whether through influencing supply and demand or by anticipating price fluctuations during speculation. Economic data and speculation resulting from economic crises in relevant countries strongly influence prices.
Second: Political Factors Manipulating the Economy for the Interest of the Political Actor:
1. The Issue of Shale Oil:
The US has surpassed both Saudi Arabia and Russia as the world's largest oil producer due to its extraction of oil through hydraulic fracturing (fracking). Bank of America stated in the summer of 2014: "The United States will remain the world's largest oil producer this year after surpassing Saudi Arabia and Russia in energy extraction from shale, which revives the country's economy. US crude oil production, along with liquids separated from natural gas, has surpassed other countries this year, with daily production exceeding 11 million barrels in the first quarter of this year..." ["The United States is seen as the largest oil producer after surpassing Saudi Arabia," Bloomberg, July 4, 2014].
The shale oil and gas revolution in the United States caused an increase in oil production from 5.5 million barrels per day in 2011 to currently over 10 million barrels per day, which allowed it to cover most of its needs. Consequently, its imports from Saudi Arabia fell to less than half—to about 878,000 barrels per day after having been 1.32 million barrels per day.
However, the problem with shale oil is its high cost, which can reach $75 per barrel, while the cost of conventional oil does not exceed $7 per barrel. This means that shale-oil-producing countries, led by America, will be dealt a fatal blow if the price of oil falls below the production cost...
2. Reducing the Price Not for Economic Need, but as Part of Sanctioning Competing Countries:
There are two international issues of global impact and interest:
The issue of the Iranian nuclear negotiations and the issue of Russia's occupation of Crimea. These two countries depend heavily on oil exports for their budgets. When the price suddenly drops by half, it undoubtedly affects their policies toward these two issues. Russia's budget relies on oil and gas—energy—for about 50%, and some estimates place it even higher. Thus, Russia needs oil prices to be at $105 per barrel to reach a break-even point in its economy.
Iran's budget relies on oil even more... it may reach more than 80% of the budget. Iran believes that the price of oil must rise above $130 per barrel for it to be viable for its internal projects and its assistance to its followers in the region. Therefore, the drop in oil prices to this low level strongly affects its budget.
Third: Reviewing the aforementioned reasons, the following becomes clear:
1. Economic Factor Independent of Political Purpose:
a- Supply and demand have remained almost unchanged in recent years; the change is slight and does not lead to this sudden drop. Until last summer, global oil prices were relatively stable at about $106 (for WTI) per barrel for nearly four years. The significant drop in oil prices cannot be fully explained economically. Oil production has been over 80 million barrels per day over the past decade since 2004. At the end of 2013, the global oil market was producing 86.6 million barrels per day, then production and demand increased at the end of 2013 and during the third quarter of 2014, making supply and demand close. According to figures provided by the International Energy Agency (IEA) in the third quarter of 2014, average supply reached 93.74 million barrels, and average demand reached 93.08 million barrels [Source: IEA website]. This is a slight increase over four years that might cause a gradual decline of a few dollars per barrel, but it cannot cause it to drop by half in five months unless the economic factor is not the primary reason.
b- Military tensions and flare-ups are also not new; they have been almost constant over the last four years... Regional crises did not intensify suddenly to cause a sudden drop in oil prices. The boiling point and tensions in the region since 2011 until now have continued at a pace that is almost expected in its events.
It should be noted that the norm during political crises in the region and the world is for oil prices to rise, as has happened in several incidents since 1973. Now, with crises worsening in Ukraine, Syria, Iraq, and Libya, the price per barrel was expected to jump to $120 or even $150 according to some predictions. This drop in prices is unusual if the causes were purely economic, because crises and wars affect supply routes, leading to decreased supply and thus higher prices—not a decrease—unless there are reasons other than purely economic factors.
c- Speculation and the exploitation of economic data: Since 2008, with the intensification of the economic crisis, things have remained stagnant; they did not worsen further but rather saw some improvement. Therefore, it can be said that the purely economic factor is not the main reason for the oil price drop to this low rate, which has exceeded a 50% decrease compared to five months ago.
2. Political Factor to Move the Economy to Serve the Interest of the Political Actor:
a- The Issue of Shale Oil:
The cost of extracting shale oil ranges between $70 and $80 per barrel. By using modern advanced technologies in extraction, this cost could drop below that, perhaps reaching $50–$60 per barrel. IHS (a research firm) believes that the cost of producing a barrel of oil from shale fell from $70 per barrel to $57 last year, as oilmen learned how to drill wells faster and extract more oil. ["The Sheikhs vs. Shale," The Economist, December 6, 2014]. Therefore, reducing the oil price to about $50 or $40 per barrel makes shale oil extraction non-viable. Even if the reduction was to $60–$70 per barrel, it remains without suitable viability because economic viability requires a proper margin between cost and selling price.
Therefore, the refusal to reduce OPEC production, or rather Saudi Arabia's refusal to reduce production, could be one of the reasons... It is well known that America exploited shale oil production because conventional oil prices rose above one hundred dollars per barrel. Thus, lowering conventional oil prices makes shale oil production unfeasible.
Conventional oil prices can withstand the reduction and remain viable because the cost does not exceed $7 per barrel, while shale oil costs are ten times that, as we mentioned earlier. Accordingly, no matter how much the price of conventional oil is reduced, it will remain profitable. As the Saudi Oil Minister Ali al-Naimi said, "OPEC will not cut its production even if the crude price in global markets drops to $20 per barrel" (Al-Jazeera, 24/12/2014). He explained that "the share of OPEC as well as Saudi Arabia has not changed for several years; it is around thirty million barrels per day, of which about 9.6 million barrels is the Kingdom's production, while the production of others outside OPEC is constantly increasing."
As is well known, the ruling regime in Saudi Arabia under the current King Abdullah has strong ties with the British. Accordingly, we can say that Saudi Arabia's interest in not reducing production and pressuring OPEC in that direction is part of a British policy agreed upon with Saudi Arabia to impact America's shale oil production.
b- When America became aware of this trend within OPEC influenced by Saudi Arabia (which holds the largest share in OPEC), especially since the Organization of the Petroleum Exporting Countries (OPEC) met at its headquarters in Vienna on 27/11/2014 and the members did not agree to cut production to support prices because Saudi Arabia refused, stating they could live with lower prices in the short term. When America realized this, Kerry visited Saudi Arabia on 11/09/2014. The US Secretary of State visited King Abdullah, the monarch of Saudi Arabia, at his summer residence in an unscheduled visit. Although the media mentioned reasons other than oil for the visit, evidence suggests that the subject of the visit was oil and its prices... It was specifically after this visit that Saudi Arabia began increasing oil production by more than 100,000 barrels per day for the remainder of September. In the first week of November, Saudi Arabia lowered the price of (Arab Light) oil by 45 cents per barrel, which pushed oil prices to fall rapidly from $80 per barrel. A senior official at the (US) State Department confirmed that global oil supplies were discussed during the meeting.
When he could not convince Saudi Arabia to reduce production, he discussed the matter from another angle and showed approval for the reduction, noting that it affects Russia (which occupied Crimea) and Iran (regarding nuclear talks). He saw that these two justifications would find favor with Saudi Arabia, but he intended for the reduction to be around (80). It seems Saudi Arabia agreed to this or showed agreement; the British The Times newspaper reported on 16/10/2014 that "Saudi Arabia has taken a precisely calculated position by supporting the drop in oil prices to around $80 to make shale oil extraction economically unviable, which forces America to return to importing oil from Saudi Arabia and pushes shale gas out of the market." This talk indicates that the British are standing behind Saudi Arabia to support it against America, which is working to stimulate its economy to get rid of the repercussions of the financial crisis, even at the expense of others and by striking them. It is well known that the current regime of Abdullah Al Saud follows the path of the British.
America showed that it had satisfied Saudi Arabia regarding the approval of the reduction. It also showed Europe that its accusation of not putting serious pressure on Russia for occupying Crimea, and not putting serious pressure on Iran regarding the nuclear energy file... it showed that this accusation was incorrect based on its approval of the oil price reduction affecting the budgets of the two countries... Then it satisfied some Russian dissidents; early in March, billionaire George Soros suggested to the US administration a way to punish Russia for annexing the Crimean Peninsula by lowering oil prices... Thus, Kerry tried to show his approval of the reduction but within certain limits, then deceive Europe and the Russian dissidents that he is serious in supporting Ukraine against the Russians, contrary to the actual reality...
However, for the first time, America finds itself unsuccessful. The winds blew where the ships did not desire, as oil continued its decline to about $60 per barrel in a few months, with Saudi Arabia insisting on not reducing production and instead increasing it. All of this generated a reaction in the oil market, as is known through the impact of psychological aspects on market prices.
Fourth: As for what is expected now:
There is difficulty in the price returning to what it was.
However, the continuation of the reduction affects both parties:
a- Saudi Arabia, and behind it Europe, especially Britain, because Saudi Arabia's budget this year has suffered a deficit of 145 billion Saudi riyals out of 860 billion riyals estimated for expenditures, i.e., a deficit of about 40 billion dollars, due to the drop in oil prices. This affects its internal projects, and more importantly, what will happen to Britain's exports to Saudi Arabia, especially weapons, due to the reduction in Saudi Arabia's budget and the deficit it suffered... British exports to Saudi Arabia in 2012 amounted to 7.5 billion pounds sterling, in addition to the investments of British companies amounting to about 200 companies with investments of about 11.5 billion pounds sterling per year. All of this will be affected by the decrease in Saudi Arabia's financial capacity due to the drop in oil prices... especially since the Saudi government budget receives 89% of its revenue from oil exports. Therefore, the continuation of the reduction affects it from this perspective...
b- On the other hand, the continued reduction affects America's shale oil production. This is because, due to high prices in past years, it invested billions of dollars in shale oil extraction in America, which appeared profitable, adding 4 million barrels of oil per day since 2008, which constitutes an influential percentage of global oil production.
Although the drop in oil prices stimulates the US economy, its loss of the shale oil trade far outweighs that, and it is not easy for it to let Europe, Saudi Arabia, and OPEC destroy its investments.
- Therefore, either America will resort to methods of modern technology to reduce the cost of shale oil production so that it becomes viable with current low oil prices—which is not easy, especially if the oil price drop continues, and it seems the drop has not stopped yet, as it was published today 07/01/2015 that it fell below $50 per barrel... or America will turn directly to Saudi Arabia, fabricating some crises for Saudi Arabia and making its budget deficit increase so it is forced to reduce production and thus increase the oil price... or it will reduce the instigation of crises for Britain in Yemen and Libya in exchange for Britain pressuring Saudi Arabia to reduce production, and then OPEC reduces it and the oil price returns to rising... Since any of these three requires plans or even conspiracies... the crisis of falling oil prices will remain a subject of tug-of-war, decreasing or increasing according to the results of the power struggle or according to compromise deals in the capitalist manner...
Fifth: International politics is in a state of stumbling and instability; no sooner does it escape one crisis than it enters another. All this is due to the corruption of the capitalist system controlling the world, which carries within it international crises, and thus creates a life of hardship for people in particular and for the international order in general... All this corruption, degradation, misery, and suffering will continue as long as the capitalist system is in control. These crises will not end except with the solutions of the Divine System that Allah has mandated for His servants, which is the system of the Righteous Khilafate that carries within it justice and tranquility for everyone who seeks shade under its wings.
وَيَقُولُونَ مَتَى هُوَ قُلْ عَسَى أَنْ يَكُونَ قَرِيبًا
"And they say, 'When will that be?' Say, 'Perhaps it is near.'" (Surah Al-Isra [17]: 51)