Tales from the Bottom of the Barrel: What’s Happening to Oil?

The story of global commodities cast a dark shadow over much of 2015 and this gloominess looks likely to continue in 2016.

The price of crude oil has fallen from $105 per barrel in June 2014 to a meager $31 in February 2016. This represents more than a 70 per cent drop in less than two years.

Commodity prices have shaken global financial markets, but the slump in oil clearly did not ensue overnight. In 2014, investors cringed at the prospect of oil prices falling below $70 per barrel. Now, as the price of crude oil plummets past ten year lows, financial analysts are eagerly speculating when and where the market will finally ‘bottom out’.

Beyond the visible impacts on the international financial system, oil continues to fuel geopolitical tensions across the world. As weak oil prices threaten global liquidity and growth in an already shaky global economy, oil production has become increasingly entangled in foreign policy disputes. While the global oil market is no stranger to volatility, its effects permeate every level of the international system. Indeed, oil represents much more than fuel: it serves as a leading political and economic indicator of the months and years to come. With no relief in sight, it seems necessary to confront the situation head-on. What is really happening to the price of oil?

Image courtesy of Sergio Russo © 2007, some rights reserved.
Image courtesy of Sergio Russo © 2007, some rights reserved.


A Story of Supply and Demand

Several economic analysts have suggested that the sharp decline in oil prices constitutes little more than ‘simple economics’. Following these accounts, the price of oil has collapsed due to overproduction and excess supply around the world—sometimes referred to as ‘oil glut’. Demand for oil has also diminished over the last several years, within the context of a widely advertised ‘global economic slowdown’. Compounding these issues, it has been suggested that global oil demand is declining because populations are becoming increasingly energy efficient. According to these narratives, excess supply coupled with weakening demand plainly accounts for decreasing oil prices.

Within these macroeconomic foundations, however, lies a more complex subplot. Price competition has escalated between several major oil producers, fostering the rise of global price wars and ‘petro-aggression’. Producers continue to play a dangerous game of chicken and have repeatedly disregarded warnings to cut their production levels. The International Energy Agency has suggested that global markets are effectively ‘drowning in oil’. Where do things go from here? It seems likely that a ‘simple economic’ explanation will not be sufficient.


Crude, Crude World 

Oil prices implicate everyone and everything— from individual consumers to entire countries and regions. Many would assume that low oil prices reap benefits for all, promoting global development and reducing costs during a period of relative economic instability and stagnant growth. While this may have proven true in years past, the world economy is far less predictable than it once was. Rather than driving industry and development, the rapid decline in oil prices has compounded existing issues— instilling fear into global investors and placing a chokehold on several major economies. The Economist recently asked: ‘Who’s afraid of cheap oil?’. In the context of the contemporary financial order, this fear seems universal.

Although distinctions between global ‘winners’ and ‘losers’ remain blurry, it is possible to draw out several, broad storylines developing as a result of the decline in oil prices. Among the most affected are, unquestionably, private oil companies and state-controlled oil giants such as Saudi Aramco, Rosneft, and Petrobras. Major oil exporters like Russia, Saudi Arabia, and Brazil are consequently scrambling to make up for lost oil revenues, which often form the bulk of annual government budgets. Tensions between Russia and Saudi Arabia have notably escalated in the competition for market share in Asia and Europe, resulting in a price war that has amplified global oil glut. The ‘re-entry’ of Iran— whose oil markets opened to global trading in January 2016 after being released from international sanctions— has equally increased apprehension and aggression among oil producers in the region. Smaller ‘petro-states’ such as Venezuela and Nigeria are also facing dire conditions due to their vast dependency on oil revenues.

While the scope of damages has become increasingly pervasive, there may be some advantages related to the decline in prices. Major importers of oil such as China, India, and Indonesia are benefitting from cheap prices. Many of these countries have been able to cut oil subsidies, which may allow governments to revitalize their domestic economies and pursue greater development and investment. While it is indeed possible to identify several sources of relief, the full extent of financial spillovers due to the decline in oil prices remains unclear.

In the midst of increasing distress and uncertainty, many have called for assistance from the Organization of Petroleum Exporting Countries (OPEC). According to its official statute, the principal objectives of OPEC include ‘the stabilization of prices in international oil markets’. In spite of collapsing oil prices and heightening geopolitical tensions, the organization has failed to play an instrumental role in curbing global oversupply and quelling dangerous price wars. Tenderly referred to as the ‘global oil cartel’, OPEC was relatively silent for much of 2014 and 2015. Its principal members—among which include Saudi Arabia, Iran, Iraq, Venezuela, and Russia—have resisted pressures for oil production readjustment but the relentless decline in prices has quickly destabilized the ground beneath their feet. 

As the effects of global oversupply have begun to exact serious tolls on their domestic economies, OPEC members like Venezuela have pushed for greater action. Although OPEC is not officially scheduled to reconvene until June 2016, several members have proposed a series of informal meetings and discussions. On 16 February 2016, oil ministers from Saudi Arabia, Russia, Venezuela and Qatar announced an agreement to freeze oil production to January output levels in order to stabilize prices. In an unlikely move, Iran announced its support for the production-freeze, signaling a potential ‘break’ in geopolitical tensions. While by no means conclusive, the recent movements suggest that the mood inside OPEC is shifting towards a greater consensus for action.


Back to the Futures

Global financial markets all too often fall victim to the short-term outlook. While declining oil prices have had undeniable effects on the global economy over the course of the last two years, the present situation is merely one piece of a larger historical legacy of ‘busts’, ‘booms’, and ‘shocks’.

The question remains, however: What happens next? While there are no conclusive answers in the world of finance, it seems likely that rallies in the price of oil may occur in the short-term, but turbulence will continue for the foreseeable future. Risks remain high and indicators of slow growth continue to endure in the current financial climate. The International Monetary Fund recently cut global growth outlooks for 2016, forecasting a slow increase in oil prices over the next few years. Tensions will persist among oil producers, and while the recent movements by OPEC have been modest, it appears that both OPEC and non-OPEC countries will be forced to address the situation in an attempt to ‘realign’ global oil supplies and expectations. The story of global oil rolls on.

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