Falling oil prices

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Talmiz Ahmad :
The plunge in oil prices has been swift and unexpected. In mid-June, oil prices were about $ 115 per barrel, having been over $ 110 for the previous year and over $ 100 for the last three years. They fell to $102 in August and to $ 98 in September. In October, prices plunged to below $ 85/barrel in the first fortnight, standing at $ 82.6 on October 16, the lowest price since 2010, yielding a cumulative fall of nearly 30 percent since June.
World markets are flush with supplies for which there are not enough consumers. The global economic slowdown is the principal culprit: with China’s growth projected at around seven percent next year, increase in oil demand is negligible. Europe is also expected to experience sluggish growth, while shale oil production has significantly reduced US imports. At the same time, not only have OPEC members not effected cuts in production, additional supplies has also unexpectedly come into the market from Libya and Iraq.
The fall in prices has triggered two competing “grand strategy” scenarios. One scenario emerges from the negative impact of the price falls on the economies of US adversaries Russia and Iran. The columnist Thomas Friedman said in mid-October that he was seeing a “global oil war” which had the US and Saudi Arabia arrayed against Russia and Iran. The latter are crucially dependent on oil revenues and will certainly be seriously affected by low prices. The advocates of this scenario believe that the pressures generated by low prices would make them more accommodative in their engagements with western interlocutors.
However, given their record, Russia and Iran are unlikely to compromise their established foreign policy positions only on account of falling oil prices. In fact, the adverse circumstances are likely to encourage domestic tenacity and greater camaraderie between the two beleaguered nations.
The other scenario sees a deliberate Saudi attempt to retard the further development of the US shale oil industry, which is crucially dependent on high oil prices of $ 80-90/barrel to sustain production. This explanation is also not convincing. While low prices may put medium term US production in jeopardy, this is hardly a deliberate Saudi ploy. The Kingdom is well-aware that shale oil has in fact stabilised world markets at a time of acute turmoil in oil producing countries. For this reason it has repeatedly welcomed new production sources, particularly since unconventional production boosts the demand for fossil fuels and reduces investments in renewables.
The simplest explanation is perhaps the most plausible: like most analysts, Saudi Arabia was surprised by the dramatic fall in prices. It realised that the fall was not a short term seasonal blip but emerged from changing market fundamentals. What it was not willing to do was to assume full responsibility for corrective action, believing that this should be the collective responsibility of OPEC. In the meantime, the Kingdom has opted to give priority to retaining its foreign markets, including through discounts for its Asian customers who buy two-thirds of its exports. There is no ”grand strategy”, merely the Kingdom coping with difficult market conditions.
Given the current account surpluses of the countries of the Gulf Cooperation Council (GCC) of about $2.4 trillion and their substantial reserves, there is little doubt that they will be able to sustain fiscal deficits in the short term. However, their commitments to infrastructure development, economic diversification and social obligations would demand huge financial outlays and make oil prices of around $100 necessary over the medium term.
In private briefings, Saudi officials are believed to have conveyed that the Kingdom is prepared to accept prices of $90-80 for a year or two so that these short term sacrifice would be made up with higher revenues and assured market share for OPEC production in the medium term, presumably when growth rates would be higher and shale oil production would start petering out. Still, the fall in prices is a warning to GCC countries to urgently address issues such as their burgeoning domestic consumption, energy subsidies and inefficiencies in energy use.
The fall in oil prices constitutes a windfall for consuming countries. For consumers, the price fall will generate revenues of $1.8 billion per day or $660 billion per year. According to the IMF, this will increase global GDP by 0.5 percent; if business confidence is also boosted, the rise may be 1.2 percent. Major importers like China, India and the European Union should be important beneficiaries. This will set the stage for increased business investment and consumer spending, and overall greater economic activity. The fall in oil prices may just pull the global economy out of its doldrums.

( Talmiz Ahmad is the former Indian ambassador to the UAE)

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