The Politics of Oil

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Oil prices have plummeted exponentially in the last year, consequently resulting in the lowest petrol prices for 5 years. With OPEC refusing to cut supply, Oil prices look set to continue falling; are the reasons purely supply and demand? Or are there other political objectives?

In January, Brent crude oil dipped below $50 a barrel for the first time since May 2009. As a result, petrol prices have more than halved over the last 6 months, vastly benefiting consumers. The rapid decrease has occurred surprisingly quickly as prices more or less remained at $110 a barrel between 2010 and 2014.

Only last week did oil prices rise slightly; Brent crude was up 1.3% at $53.65 a barrel, while US oil rose 1.7% to $48.52. Despite the incremental increase, the decline has dragged UK petrol prices to a five year low.

Supply and Demand?

The vast drop in oil prices is down to a culmination of different factors. Firstly there is a huge glut in supply with more oil being produced than ever before, contrary to the fact its a finite resource.  Saudi Arabia, the largest oil producing member of OPEC,  has increased crude oil production significantly.  In December 2009 it produced 8 million Barrels a day, by the end of 2014 this had grown by 18.46%,  to  9.64 million barrels a day. This increase has taken Saudi Arabia’s OPEC market share to a whopping 22%. Additionally, non OPEC members such as the U.S saw a huge upsurge in shale gas investment due to consistently high oil prices between 2010 and 2014.

Fracking in states such as North Dakota has created a shale boom, increasing global supply further. The technique extracts oil and gas through blasting underground rocks with chemicals, sand and water . In 2013, shale comprised 20% of global investment in oil production, seeing its percentage of global oil output rise to almost 4%.

Whilst supply has seen a boost due to cheap extraction, high prices and new investment, demand has fallen in tandem with a global economic slowdown. Oil is fundamentally the backbone and core feature of our infrastructure, meaning that even slight changes can alter demand. Europe remains in crisis as countries continue to  implement fiscal austerity. This has dramatically reduced aggregate spending across the region, with businesses  producing less, and in turn, requiring less commodities.

If we look east; China’s fall in annual growth has additionally contributed to a lack of demand. In recent years, China’s integration into the global economy played a huge part in the expansion of oil prices. The U.S only outpaced China’s growth of oil consumption in 2013 for the first time since 1999. This loss of appetite for oil is a direct result of  smaller growth rates after a decade  9% a year expansion (on average).

Chinese Annual growth rates between 99-2014

Geopolitics?

If we look more closely, its evident Saudi Arabia have various motives explaining their decision not to cut supply. Financially it’s in their interest to reduce U.S shale production in an attempt to preserve their market share. This is possible due to shale’s relative infancy, with the cost being higher than traditional methods of oil extraction. Shale requires the price of oil per barrel to be relatively high and becomes unprofitable at $70 per barrel. In the OPEC middle east, extraction costs are relatively low due to their accessibility and concentration, allowing Saudi Arabia to continue supply without risk of sacrificing profitability.

Investors are are able to make a 10% return with oil trading as low as $20 per barrel.  OPEC currently hold 40% of global reserves,  and consistently  high prices have enabled  members to generate vast amounts of wealth. The emergence of fracking represents a severe threat to long term OPEC oil revenues, creating a motive to continue current supply in an attempt to remove shale’s competitiveness.

King Salmon of Saudi Arabia
King Salmon of Saudi Arabia

Whilst fighting the development of fracking on one front, the Saudi’s have publicly declared their condemnation of Russia’s support for the Syrian regime. The maintenance of OPEC oil supply has financially crippled Russia. Almost 70% of the country’s export revenue is derived from oil, and the free fall in prices have massively dented the revenues entering the Kremlin.

Saudi Arabia have vested interests in Syria, and it aims to flush out Assad’s government which continues to exclude the Sunni population.

The Saudi led effort to place Russia’s economy under huge strain is punishment after Putin’s armament of President Assad’s forces . King Salman has committed to bank rolling the rebel Sunni effort attempting to overthrow the Syrian government who only represent the Alawite, Christian and Shiite populations. Removing Assad would represent a major blow to Iran,  who’s Shiite alliance with Syria has mutually benefited both countries.

 

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