According to some forecasters the price of oil might hit $75 a barrel soon. Goldman Sachs has even predicted a $70 barrel of West Texas Intermediate (WTI) in 2015. If the price does drop this low it will be a dramatic change from the recent status quo; a relatively stable, higher price of over 90 dollars per barrel, since late 2012. According to Bloomberg news Brent Crude, which is usually considered the global benchmark price (rather than WTI), hit “$82.60 a barrel on Oct. 16, the lowest in almost four years, from $115.71 on June 19“. Indeed the latest prices represent a more than 25% drop from the June peak and, further, this has meant that, at a national level, nearly all of the world’s major oil producing countries are now losing money per barrel sold.
So what caused this sudden drop? There is a range of reasons but, at its simplest, a lower oil price can be explained as a product of slower demand and increased supply. Mainstream analyses tend to identify several broad factors in the changing nature of the market. While it is true that all of these market-factors play a significant role, there may be certain political motivations behind some decision-making that should also be considered relevant to recent drop in oil price.
Supply and demand
According to most mainstream analyses, on the demand side, there are a number of significant changes affecting many of the larger oil consumers. In particular recent term factors, such as an economic slowdown in China and India – which, together, formerly led thesurge in recent years of global liquid fuel consumption – combined with longer term changes in the already industrialised West where technological advancements have led to greater fuel efficiency and diversification away from crude oil as an energy source.
On the supply side, the surprisingly rapid increase in production of Libyan oil (effectively tripling since the fall of the Gadhafi regime in 2012) has occurred at the same time as other oil sources – specifically the shale and tar sands oil industries – have come into their own. Indeed the rapid increase in North American production, particularly driven by output from Canadian tar sands and US shale, caused a “supply shock that is sending ripples throughout the world,” according to International Energy Agency Executive Director Maria van der Hoeven, speaking at Platts Crude Oil Summit in London in May. Further, this may be supplemented by a new Mexican ‘Oil Boom‘ too.
The reality of a changing landscape for oil production was acknowledged in May by Abdalla el-Badri the Secretary-General of OPEC – the Organisation of Petroleum Exporting Countries, a collective of oil producers formed in the 1960s as a means to counter the, then, dominance of a collection of western companies known as the Seven Sisters –. El-Badri’s remarks suggested that OPEC view of North American Production is that it represents a short-term spike, but not a long term threat. “It is essential that we put things into some context, and examine the market over all timeframes,” El-Badri said.
Indeed according to The Economist the world is now in the midst of such a “supply shock“, comprising increased production from both within and outside the OPEC cartel.
Today’s falling prices are caused by shifts in both supply and demand. The world’s slowing economy, and stalled recoveries in Europe and Japan, are reining back the demand for oil. But there has been a big supply shock, too. Thanks largely to America, oil production since early 2013 has been running at 1m-2m barrels per day (b/d) higher than the year before. Other influences are acting as a brake on the world economy … But a price cut of 25% for oil, if maintained, should mean that global GDP will be roughly 0.5% higher than it would be otherwise.
So is it that simple? Is it only that there are more producers and slower demand now so should we overlook other factors? Maybe. Perhaps it is best not to look a gift horse in the mouth, and such a drop in oil price is indeed likely to be a boon for economic growth,particularly in Europe. But there is also something odd about this situation, which becomes evident when one views these developments within a broader historical context. Surely, when most oil production is in many countries, largely state-owned industry, the event of a ‘supply shock’ must – to some extent at least – be the product of political choices.
What ever happened to those concerns of scarcity?
In particular it is useful to turn back the clock to more-or-less the point at which the recent spike in prices occurred. This was mid-2012 and, as most analysts agree it was driven by speculation that there would be a sudden scarcity of supply due to the Libyan uprising. Indeed, according to most mainstream analyses conflict in the Middle East has more-or-less always contributed to uncertainty over the oil supply and a spike in prices.
So what has changed here? As stated above, obviously Libyan oil has more than returned to the pre-spring levels, but its ability to maintain this supply uncertain, particularly given the on-going severe instability there. Further, there are plenty of other reasons for speculators to be concerned with instability and potential scarcity.
For example, Russia – the world’s third biggest supplier of liquid fuels – is currently locked in an on-going conflict in Ukraine, and is subject to damaging sanctions from Europe and the US; an interim deal between Iran and the P5+1 of its pursuit of nuclear facilities is due to lapse on 24 November; and Iraq and Syria are currently in the grips of internal strife andforeign invasion, while much of their respectiveterritories – and some of their oil supplies – remains under the control of an unpredictable international pariah.
So, clearly, there remain several very significant reasons for continued concern over scarcity and more than enough reasons for suppliers to cut production and take advantage of higher prices. Moreover, it is very much in the interests of every actor with influence (on the production side) over the market to sell at a higher price. Indeed for many actors the production and selling of oil becomes unprofitable as the price lowers. And this is as true of the newer shale and tar sands producers as it is of the powerful state-run (or semi-state run) oil companies of OPEC.
Running at a loss: ‘differential accumulation’
So why continue to produce at the current rate when the effect is to lower the profit margin per barrel? Most mainstream analyses offer a simple ‘free market’ account of this phenomenon: that there is a price war going on as suppliers compete with each other for market share.
Yet, while there is some strong evidence to support this claim – for instance, the fact that Saudi oil producers have cut their prices particularly for the US market, in an effort to undercut American and Canadian producers on their home turf – we should not overlook the possibility of other potential political motivations.
Indeed, the history of the oil industry teaches us two important lessons that should continue to be taken seriously. First, even where there is evidence of some competition within the energy sector this is hardly enough to classify the production and sale of oil as a ‘free market’. Rather, it is a sector which is, and always has been, dominated by extraordinarily powerful actors who deal in ‘black gold’, the world’s most important tradable commodity.
A good example of how this has worked in the past the fact that Saudi Arabia – the world’s biggest oil producer – has frequently acted as a ‘swing producer’, which according to the text book definition, means it has, “deliberately limit[ed] its crude oil production in an attempt to keep supply and demand roughly in balance.” Indeed since the use of the 1973 ‘oil weapon’ – which established a radical shift in the balance of power over oil – there are numerous occasions when Saudi Arabia acted in this way as regional events brought disruption to other OPEC suppliers (for example: during the Iranian revolution, the Iran-Iraq war, the 1990-1 and 2003 wars in Iraq and during the 2011 in Libya). On these occasions, increased Saudi production served to (a) offset disruption and maintain stability in the market, but also (b) brought significant profit windfalls to the kingdom as it increased its market share.
The second lesson is broader. It is that power – be it in the form of political power or financial capital – only makes sense when understood in relative terms. That is to say: power is only really worth anything if you have more of it than your competitors. This is what the two radical economists Jonathan Nitzan and Shimshon Bichler call ‘differential accumulation’. (Indeed,Nitzan and Bichler argue that a much more complex relationship between the profit margins of oil producers, weapons manufactures and the occurrence of conflict in the Middle East exists, than would be apparent from most mainstream analyses).
In other words, what I am describing here is a view of the world that sees the main priority for elite actors (such as those people with influence over oil production) as maintaining or increasing the gap between themselves and their nearest competitors. With this in mind, we can see that not only is it important to accumulate power/capital more quickly than ones competitors in the good times, but also to take advantage of the bad times by ensuring that one loses power/capital more slowly than ones competitors then too (or that ones competitors are at a greater disadvantage so that they suffer more during those difficult times).
This view is a different response to the recent oil price drop and answers the question: why would those actors with influence over the market – particularly the Saudis – act in a way that apparently harms their own profit margin?
The cut in prices clearly harms all producers by reducing the amount of profit per barrel, but it certainly harms some more than others. For example as demonstrated by The Economist recently, the current oil price has dropped below the ‘break even price’ for all major suppliers (with the exception of Kuwait), and this includes the traditional ‘swing producer’ Saudi Arabia. But the drop is far more damaging to several international actors, most of whom happen to be strategic rivals to either Saudi Arabia, and/or its closest ally, the US (e.g. Russia, Iran and the Islamic State).
The likely consequences of these conditions then are good – in the short term – for consumers but for producers this lower price represents a test of their ability to withstand lower profit margins. In purely economic terms this means that for some suppliers – notably the North American shale and tar sands manufactures – this is likely to be damaging but not necessarily fatal. But if we look at the situation though the lens of provided understanding power as a relative phenomenon, we can see that the lower oil price could have a significant impact on three of the US & Saudi’s strategic rivals, which could add an important layer of extra pressure that encourages them to make important concessions.
These are: Russia, which is facing off against the US and Europe over its annexation of parts of Ukraine; Iran which is in the midst of negotiating with the P5+1 over its nuclear deal; and the Islamic State which has been selling oil to support its military campaign in Iraq and Syria. The lower oil price hurts all of these actors far more than it hurts Saudi Arabia, or North American producers, and importantly it hurts them all when each are facing a critical conflict with the West.
This view of the recent drop in oil price suggests that that beyond the impact of market factors, the Saudis in particular, are taking advantage of the situation to punish strategic rivals of themselves and their closest ally. We should not overlook the potential impact of such a strategy as those political conflicts continue to unfold.
The author would like to thank Polychronis Kapalidis and Oliver Leech for their helpful comments on this article.
Dr Philip Leech is a visiting research fellow at the Council for British Research in the Levant. He is on twitter @phil_haqeeqa and his academic profile is available at academia.edu.
This article was originally published by Middle East Monitor on Wednesday, 12 November 2014