The New Global Economics of Low Crude Oil Prices

The New Global Economics of Low Crude Oil Prices

In part one of this blog I wrote about what is driving the price of crude oil to record lows. But how does low oil prices impact profitability and production?  And what impact does this have on driving global economies in the future?

It is no secret that exploring and producing oil and gas is very costly.  Some reserves are more expensive to exploit than others and only a high oil price can justify the costs associated with exploration and production of oil. The figure below illustrates the price of barrel of oil and its impact on economically viable oil reserves for OPEC and non-OPEC countries at the current price point of $32.18/barrel.  For Saudi Arabia (and most of the OPEC nations), it is profitable to produce oil even when the price is at $20 due to its readily accessible reserves. On the other hand, for the non-OPEC nations the price needs to be closer to $60.

The non-OPEC nations that opoil reserve priceserate nationally-owned companies (NOCs) are especially deeply impacted by falling oil prices as that leads to a direct decline in their revenues. There is speculation that the slowdown could bring political instability to fragile countries of the world such as Venezuela. The rapid drop in oil prices has also led to budgetary crisis, weaker GDP growth, falling currencies and inflation, leading to tighter monetary policies in some of these countries. Central banks in Colombia and Mexico raised interest rates in December in an effort to keep inflation down. Russia, as a big oil producer, is feeling strained as well with rising taxes and inflation.

These high cost non-OPEC nations need to pivot quickly to optimize and improve efficiencies of their production activities. As the oil prices have been high for the better part of the last decade, there has not been a lot of emphasis on streamlining operations and eliminating waste from activities. This is changing now and production efficiencies are being slowly realized. Competition makes everyone better and it is inevitable that only the strong will survive.

Cheap oil prices has its benefits as well. As consumers are now spending less at the pump, they have more disposable income to spend on other items that they may desire. In fact, as shown in the graph below, decline in oil prices impact GDP for different nations.  There are nations who are doing extremely well and are seeing GDP growth as their economies are not dependent on revenues from oil.

disposable income spending

The next few months will be exciting, albeit nerve-wracking, to examine what happens next to the price of oil and its impact on world economies. On one hand, countries like India and China have benefitted from low oil prices. This will give leaders of industrializing nations an opportunity to transform their economies and remove inefficiencies. Oil importing countries, such as South Korea, will have an opportunity to tear up wasteful energy subsidies, or curb deficits by raising taxes. On the other hand, oil and natural gas dependent economies like Saudi Arabia, Malaysia, and Venezuela need to quickly embrace some sort of an economic reform in order to generate revenues from some other sources.

The oil shock of 2016 comes as the world economy is still trying to rebound from the aftermath of the financial crash of 2008. For the immediate future, our dependency on oil remains strong thanks to low oil prices. It is my hope that technology-heavy nations, like the US, will continue to drive innovation and improvements in efficiencies and creating economically viable “green” or sustainable energy solutions to economically compete and reduce the dependency on fossil fuels such as, coal, oil and natural gas and create a more balanced energy portfolio.

 

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