Keeping Score in the Oil Game: Price and Politics

By Harry Richart

Recently, there has been much discussion regarding the precipitous fall of oil prices across the globe over the course of the last several months.  Expectedly, media outlets and academics alike have thoroughly debated both the positive and negative outcomes associated with the recent price drop, and how these events correspond to the global economy at-large.  Despite a relatively extensive discourse surrounding this topic, an informed observer could hardly claim that a consensus has formed regarding the worldwide political and economic outcomes directly influenced by the drop in crude prices.  What we can be certain of is that prices will eventually rebound, although it remains difficult to forecast when and how rapidly prices will increase.

The current depressed state of oil prices stems from a few different factors, the first of which is a positive supply-shock brought on by more significant crude producing countries across the globe.  In particular, recent increases in US and Canadian output, especially from oil sands, has been somewhat surprisingly countered by sustained production from OPEC, likely in an attempt to put financial strain on North American producers.  By weakening increasingly relevant US and Canadian oil firms, OPEC may be able to create a situation where it can reclaim some of its lost market share by exercising it’s ability to financially withstand a protracted period of high-production and low prices.  This strategy may work for some of OPEC’s member-states (namely Saudi Arabia and other Gulf States), but it has dealt a devastating economic blow to other members finding themselves in a more unfavorable financial situation (Venezuela, Iran, Nigeria).  To frame the current situation facing major oil producing countries, the contents of this post will offer a brief synopsis of the situation occurring in a number of countries most deeply affected by the recent price decrease in benchmark crude.

NEWLY_ARRIVED_DATSUNS._OIL_DERRICK_IN_FOREGROUND_-_NARA_-_542632
Source: National Archives and Records Administration, College Park

The Losers: Russia

The current issues in Russia both politically and economically are troubling, to say the least. Russia’s overreliance on its energy sector, combined with a wildly weakened Ruble, and political instability both domestically and abroad, make the current drop in oil prices acutely problematic. Although President Putin has enjoyed high public approval for much of his time in office, nothing breeds widespread public discontent like a tanking economy.  Russian dependence on its energy sector for national income will remain a pressing issue if prices remain in the $60/bbl range for long, where a weakened energy sector would spread to other areas of the economy and eventually into domestic politics. Assuming that prices will rise soon enough for the Russian’s to avoid default or a recession, it will be imperative that they move to slowly diversify the complexion of their national economy. In spite of Russia’s current predicament, there should be little expectation for such an initiative from the Kremlin, thanks to deep-seeded institutional corruption.  As such, Russia will continue to place its economic and political stability largely in the erratic hands of international commodity market cyclicality.

Venezuela

Venezuela and the Maduro government’s inability to keep items such as milk, soap, paper, and prophylactics on store-shelves across the country have recently become something of an international punch line.  Although the situation may be something of an interesting anomaly for observers spectating via television or the Internet around the world, it is hardly amusing for the Venezuelan people.  Venezuelan crude requires a relatively expensive production process, making it less competitive than many other competitors on the worldwide market. This drives up the breakeven price necessary to yield any national income from crude, which is badly needed to stabilize the tanking Venezuelan economy.  This reality of higher production costs; combined with current oil prices, an inept and corrupt government, and a resource cursed economy make the present outlook seem quite bleak for Venezuela not only economically, but also politically.   In a manner similar to the Russians, surviving this turbulent period of low prices with a long-term goal for achieving greater economic diversification would be an ideal reaction to its current problems.  Also like the Russians, there remains the fact that there is little hope for this type of economic reform, particularly if Venezuela’s governmental hierarchy remains unchanged.

Nigeria

Although crude production makes up a significant portion of the Nigerian economy, it enjoys greater diversification than Russia and Venezuela.  What makes the Nigerian case so concerning are the severe political and security problems within its borders.  Despite recently reported victories over the terrorist group Boko Haram, it will remain imperative for the Nigerian government to have access to adequate funding to conduct counterterrorism operations within its borders. The national security threat posed by Boko Haram and other extremist groups operating in the region will not be defeated easily or cheaply, making the extra liquidity created by crude sales all the more important to the Nigerian government.  Additionally, multiple financial institutions are reporting that the coming election on March 28th could cause political instability great enough to negatively affect oil production, bringing further hardship to Nigeria’s energy sector.  Under normalized political circumstances Nigeria seems fairly well suited to withstand sustained price depreciation in crude markets, but the unique set of challenges facing it have placed the government in an uneasy situation, making the potential effects of a protracted price drop all the more concerning.

Mixed Bag: The US, Canada & the EU

While low prices may prove largely detrimental to some oil-exporting states, there are other nations experiencing both positive and negative effects created by the variable nature of each sector in the economy.  In the case of both the US and Canada, lower prices for oil has lead to lower costs for firms and extra discretionary income for households, helping to increase consumption and investment levels and spark greater economic growth.  Unfortunately, low prices are beginning to put pressure on North American energy companies, raising concerns that firms may need to cut production due to lower revenue streams.  Although it is reasonable to assume that these types of negative effects would be confined to energy-related sectors of the economy, an extended period of low profitability in certain portions of the economy can quickly lead to more serious macroeconomic issues.  Recent growth and falling unemployment in both the US and Canadian economies indicates that overall, lower crude prices appear to be a boon for both nations.  Ideally both governments will prove they are up to the task of handling distributional effects caused by the previously mentioned disturbances in the energy sector.

The scenario currently playing itself out in Europe is different in many regards to that being experienced in the US and Canada.  Although cheaper crude prices are proving beneficial to certain firms and consumers across the continent, the current price of crude has driven asset prices downward across all sectors.  This downward trend in asset prices has lead to disinflation, and has played a major role in prompting a large-scale Quantitative Easing (QE) package from the European Central Bank (ECB) to bring consumer-price inflation closer to its target rate at just below 2%.  The longer that crude prices remain low, the longer asset prices and consumer price inflation will follow suit.  Even though printing money may not be the correct solution to the Eurozone’s problems (there may be none), it appears to be the only feasible solution left to revive lower than desired consumer-price levels.  If the ECB’s QE policy is miscalculated and subsequently implemented in a manner inconsistent to what an appropriately sized and timed central bank balance sheet expansion would be, then economic outcomes can be very worrying, particularly if the Eurozone’s disinflation turns into rapidly rising inflation as a result of a QE initiative that is too large.  In short, preexisting problems are making lower crude prices more worrying for many in Europe and have led to somewhat risky ECB sovereign-bond purchases.  Hopefully, QE in the Eurozone will help stabilize price levels and foster greater economic growth going forward. If not, Europe and North America must count on a rise in the price of crude (and eventually asset prices) if they are to achieve inflation and growth values in the neighborhood of their target levels.

Winners: Saudi Arabia, the Gulf States & Others

Admittedly, there are many other winners outside the Middle East benefiting from the drop in oil prices.  Populous countries like China and India who are not involved in large-scale crude production are certainly benefiting from lower prices while very few distributional effects are experienced in any of their domestic economic sectors.  In addition to these nations, Saudi Arabia and other Gulf States like Qatar and the UAE will benefit in the long-term from lower prices, especially if the Saudi’s plan to crowd out North American production is achieved.  These nations can produce efficiently enough, and have enough cash and asset reserves, that they would be able to weather a period of low prices for longer than many other resource-exporting countries.  The structure of their respective governments, vast amounts of accumulated wealth, and a relatively cheap production process make this type of policy decision viable for OPEC and the Saudis and is something that may pay large dividends in the medium- to long-term.


Harry is a master’s student working on a concurrent degree from the Patterson School in International Commerce and Security, and the German Studies program.  He has taught German language and literature courses throughout his time as a graduate student at the University of Kentucky and studied abroad at the Ruprecht-Karls Universität in Heidelberg, Germany.

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