|SocialismToday Socialist Party magazine|
Issue 187 April 2015
What low oil prices cost the world economy
The shale oil revolution in the US and Canada has produced a world oil glut – and a slump in investment in high-cost oilfields. Lower oil prices have given a boost to economic growth in the US and oil importers like the EU, India and Japan – but thrown oil producers like Russia, Nigeria and Venezuela into crisis. They have split Opec and sharpened the competition between oil importers and exporters. Far from being an unqualified ‘plus’, the sudden plunge of oil and gas prices has underlined the volatility in the world capitalist economy. LYNN WALSH writes.
The price of oil has plummeted since last summer, from over $100 per barrel to around $50 per barrel. In the past, this would have been a cause for celebration among capitalists. Historically, cheap oil and gas has been associated with periods of growth of the world economy. Indeed, even in recent months, cheap oil has given a boost to the major economies, particularly to the US. Feeble recovery since the financial crisis of 2007-09 has gained some extra lift.
Yet the celebrations are muted. While importers gain from low oil and gas prices, especially if sustained for several years, they spell crisis for states that depend on oil revenues to sustain state expenditure, for instance, Russia, Nigeria, Venezuela, Iran, etc. Overall, the falling price of oil could mean a $1.5 to $2 trillion transfer from oil exporters to oil importers. The plunge in oil prices spells shifts in geopolitical relations, as some producers are weakened, with unpredictable repercussions.
As it returns to importing oil, the power of US imperialism will be weakened internationally. There will be intensified competition between oil exporters. Lower prices mean a cutting back of oil exploration and investment in high-cost areas, such as the US shale oilfields, and Britain’s North Sea oilfields. Depending on local conditions, oil production in high-cost areas is no longer profitable when oil falls below about $80 per barrel.
This has already led to reduced investment, unemployment in the energy sector, and a slowing of economic growth in recently booming oilfields. On balance, says Janet Yellen, head of the US Federal Reserve, lower oil prices are "a significant overall plus" for the US economy. The average household in the US in 2015 will save $750 over 2014 as a result of cheaper oil, thus gaining disposable income. But the uncertain effects internationally are causing jitters among many capitalist leaders and strategists.
Supply and demand
Why has the price of oil fallen so sharply? It arises from a combination of increased supply and reduced demand. The IMF (WEO Update, January 2015) estimates that 60% of the fall in price is due to increased supply and 40% due to reduced demand.
The increased supply mainly comes from the US and Canada, from the development of shale oil. This was made possible by new technology – horizontal drilling and fracking techniques. Fracking (hydraulic fracturing) involves injecting water and chemicals at high pressure into underground rock strata to force out oil or gas. Many of the new techniques were developed by long-term R&D investment by the US Department of Energy (see: Behind the Drop in Oil Prices, the Hand of Washington, International New York Times, 22 January 2015). In response to the restriction of US oil supplies by states in the Organisation of Petroleum Exporting Countries (Opec) in 1973 and 1979, the US saw the achievement of energy self-sufficiency as an imperative. The US and the big oil companies which adopted the new techniques have brushed aside objections to the environmental destruction caused by fracking and other destructive methods.
Massive investment in the development of shale oil brought a surge in production in the US and Canada. The exploitation of shale oil added three million barrels per day (3mpd) to US output since 2012. There has also been a one million barrels per day increase from Canadian shale oil. By the end of 2014, US oil production was 80% higher than in 2008.
With the current fall in the price of oil, however, there is likely to be a sharp fall in investment in exploration and new drilling. This has already led to the closure of oilfields and to job losses in US states such as Texas, North and South Dakota, etc. Output from fields that have already been developed will continue for several years. After four or five years, however, the current slump in shale oil exploration and drilling, and declining output, will once again result in a rise in oil prices.
A few years ago, many commentators claimed that the ‘fracking revolution’ would propel a new boom in the US. For instance, Charles Morris published ‘Comeback: America’s New Economic Boom’ (2013). But it has done little more than support a weak, uneven ‘recovery’. Conjunctural trends, moreover, do not last forever. Now, for at least a period, shale oil exploration has reached its limits. There is a mismatch between the investment cycle in oil and gas production, on the one hand, and the investment cycle in the wider economy, on the other, a contradiction that will never be overcome in an anarchic capitalist economy.
The surge in oil output coincided with a sharp fall in demand. This is mainly due to a slowdown of major oil importers, notably China, as well as so-called ‘emerging markets’ (semi-developed economies). This year, for instance, the IMF expects China to grow less than 7% – compared with 10% to 12% per annum several years ago. Near-zero growth in Japan, the EU and elsewhere has also reduced demand for oil. (In contrast, cheaper oil has boosted growth in India, a major oil importer. GDP growth is expected to be over 6% this year compared to 5% in 2013.)
This conjunction of higher oil production and reduced demand has led to a glut in the international oil market – at 1.5mbd to 2mbd.
Oil giants slash investment
"Around the world, oil companies are cutting budgets, paring oil costs, slowing down projects and postponing new ones". (Daniel Yergin, Who Will Sink the Oil Market? New York Times, 23 January 2015) When oil was over $100 per barrel, the oil giants made super-profits – now as profits are squeezed they are ruthlessly cutting back their investment, and shedding workers. It is not just shale oil drilling that is being abandoned, but also new investment in other high-cost sectors, such as deep-water and Arctic fields. Yellen says that cheaper oil is a "significant plus" for the US economy, but the cut-backs are having a devastating effect on the states (especially Texas and the Dakotas) which were the main areas of shale oil drilling. Overall, employment in the US is growing slowly, but in the energy sector there are huge job losses: 20,193 cuts in January, and 16,339 jobs in February.
There is a similar situation in Britain. Output and investment were already declining in the North Sea basin before the plunge in the oil price. The North Sea fields are becoming exhausted. Oil and Gas UK, an offshore operators’ association, says "a fifth of production or a third of fields, is now unprofitable. Cash losses, or deficits after subtracting costs from revenues, topped £5 billion last year, the biggest shortfall since the 1970s". (Financial Times, 25 February 2015) Investment in the UK section of the North Sea is expected to fall from $19.2 billion in 2014 to $10.8 billion next year. The energy sector in Britain accounts for around 450,000 jobs and thousands of them will now be threatened.
BP and Conoco have announced layoffs in recent weeks, and there will be more to come. Shell, the Anglo-Dutch oil company, recently announced that it would cut investment by $50 billion over the next three years.
There is pressure on Opec, particularly from Nigeria and Venezuela, to cut output (through members agreeing to lower output quotas) and thus raise prices. Russia, which is not an Opec member, is also calling for output restrictions (though in previous episodes of over-supply Russia refused to cut output together with Opec members). Historically, this has been Opec’s policy. In 1973, for instance, Opec imposed an oil embargo on the major capitalist economies, which led to a quadrupling of oil prices. This was partly a protest against the western powers’ support for Israel in the Arab-Israeli war (6-25 October 1973). It was also a move to recover oil revenues in real terms, when revenues had been drastically undermined by inflation, especially the fall in the value of the dollar (in which oil prices are denominated). In the more recent period, however, Opec has generally cooperated with the US and other major capitalist powers in fixing a price that was considered to balance the interests of producers and consumers, and promote steady growth in the world economy.
Now, there is a deep split within Opec. It is no longer functioning as a unified cartel. Saudi Arabia, the United Arab Emirates, and Kuwait, who between them account for around half of Opec production, are refusing to cut output. This marks a drastic change in the policy generally pursued by Opec in the past. The production costs of Arabian oil are lower than for most other producers. Saudi oil costs under $10 per barrel to produce, while shale oil costs between $30 and $90 per barrel depending on local conditions. The Saudi regime needs a price of $80 to balance its current state budget, but it has reserves of $750 billion which it will draw on to sustain its price policy. If Saudi Arabia and its allies cut production and raise prices they would be helping to sustain output in areas with much higher production costs. In that case, they would inevitably lose market share. So they prefer to sustain losses for a period in order to keep prices low and increase their share of the world oil market.
The Saudi oil minister, Ali al-Naimi, made their policy quite clear: "It is not in the interests of Opec producers to cut their production, whatever the price is. If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, US shale oil producers will take my share".
This is a policy for low-cost producers, like Saudi Arabia, UAE, and Kuwait, with big reserves to carry them through a period of low prices. But several years of low prices spell disaster for exporters like Russia, which have much higher production costs and have come to depend on a high oil price to balance their budgets.
The Russian economy has been thrown into crisis by the slump in the price of oil. Big companies, with the oil and gas giants at the fore, are queuing up for state bailouts. The state has two sovereign wealth funds totalling $150 billion and foreign exchange reserves of $360 billion. But these rapidly depleting funds are being drawn on to support the plunging ruble, bailout floundering companies, supplement the federal government budget (including paying pensions), and rescuing major infrastructure projects. At the same time, sanctions imposed by the western powers over Ukraine are increasing the strains on the economy, which appears to be heading for a slump.
Cheap oil is not going to lift the world economy out of the doldrums and propel accelerated growth. Cheaper oil has given a limited boost to oil importing economies. But even the falling price in oil has been tempered by the rising value of the dollar against the weaker currencies of many importers. "For many importers, the boost from lower oil prices – while sizeable – is somewhat muted by the recent currency depreciation against the US dollar, which implies a smaller oil price decline in domestic currency". (IMF, WEO Update, January 2015)
Moreover, reduced oil and gas prices (which through transport, storage, etc, affect a wide range of prices, especially food) have reinforced the trend towards disinflation (a general slowing of price rises) and deflation (a tendency of prices to fall). This trend, which major central banks are attempting, unsuccessfully, to reverse, depresses investment and consumer demand. The fact that the Federal Reserve has yet again postponed an interest rate rise shows that the US authorities are far from confident that the US recovery has achieved a self-sustaining momentum.
There is still volatility in global financial markets, and quantitative easing in particular has created property and asset bubbles in the US, Britain and elsewhere. Now the adoption of QE measures by the European Central Bank, which will have a minimal effect in stimulating growth, will once again bring the possibility of financial bubbles. The plunge in the oil price is clearly a mixed blessing for the capitalists internationally. This is recognised by the WEO Update (January 2015): "Sizeable uncertainty about the oil price path in the future and the underlying drivers of the price decline has added a new risk dimension to the global growth outlook".