Tag Archives: OPEC

Oil price rises a sign of a healthy global economy.

Oil prices have been irregular over the last four years with the price of a barrel of oil being over $100 in 2014. This price had been suggested as the new $20 due to scarcity of oil reserves. However by 2016 the price had dropped to $28 a barrel the talk was that there was a global glut. Today the price is around $70 and analysts have been perplexed as to what is behind this increase. According to The Economist three significant questions arise:

1. Why has the oil price more than doubled in the space of two years against all expectations?

The 2016 slump in prices ($28) was in part due to the weak demand and an abundance of supply – simple economics. But demand recovered quickly and in particular the Chinese economy quickly pepped up its economy with fastest growth rates. On the supply side OPEC were able to restrict output and stocks of oil in the US started to fall. This saw D > S = P↑. Usually when there is an increase in price it attracts other sources of oil which are more expensive to extract – eg shale oil in the US and the tar sands in Canada. This is in turn will increase the supply and lower the price. But small suppliers are finding it harder to increase output as the financiers want more focus on profit rather than output. It can take months before oil actually comes on-stream.

Source: The Economist 20th January 2018

2. Why have stockmarkets been pleased with higher oil prices when it is usually associated with economic crisis?

The overall impact of higher oil prices has been to reduce aggregate demand in the global economy. With higher prices one might expect that the profits would be pumped back into the circular flow and therefore stimulating AD. However the Middle East producers tend to be big savers of oil profits at the expense of oil consumers in the West. Also countries have become less reliant on oil – demand peaked in 2005. Oil exporters depended on high oil prices to fund their government spending as well as importing consumers goods – Venezuela is a classic example of an economy that has relied on oil revenue for over 80% of government spending. Most big oil producers in the Middle East need the price of oil to be above $40 a barrel in order to cover their import bill. But a rising price of oil is usually a healthy sign that China is growing as it is the world’s biggest importer of oil.

3. What will be the ‘normal’ price of oil?

The critical change in the oil market from 30 years ago is that there is now an abundance of oil. Back then it was seen as an asset rather than a consumer good – oil in the ground was like money in the bank. But new sources of oil such as shale and tar sands have amounted to the existence of plentiful reserves. It must be added on the demand side the gaining momentum of mass-market for electric cars have reduced the demand for oil. It is being suggested that not all oil will extracted as there will not be enough demand. It makes sense that the five big producers in the Middle East – Saudi Arabia, UAE, Iran, Iraq and Kuwait – which can extract oil for under $10 a barrel, to undercut high-cost producers and capture the market share. So it is better to have money in the bank rather than in the ground. Will oil prices plunge? Unlikely especially when oil exporters are cannot sustain low prices for very long – in order to fund their expenditure they need oil prices of $60 barrel.

Source: The Economist 20th January 2018 – ‘Crude Thinking’

 

Oil prices increase – OPEC reduces supply 

The Organisation of Petroleum Exporting Countries (OPEC), is a cartel of 12 countries made up of Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Recently OPEC countries have proved skeptics wrong by deciding to cut oil production. Previously OPEC seemed quite content maintaining oil supply levels even with low oil prices – maybe with the intention of driving prices down and putting companies with high costs of extraction out of business. But the collapse in oil prices since June 2014 – see chart –  has battered the economies of oil-producing nations as some investment projects are no longer financially feasible and this could result in a new supply shortage within a few years.

oil-2000-2015

However a deal signed in Algiers in September has seen OPEC countries will reduce production for the first time since 2008 by approximately 1.2 million barrels per day (bpd) which means its production is around 32.5 million bpd – see table below:

Agreed crude oil production adjustments and levels*

opec-production-cuts

* Reference base to crude oil production adjustment is October 2016 levels, except Angola for which September 2016 is used, and the numbers are from Secondary Sources, which do not represent a quota for each Member Country.

From the table the big cuts in production are from Saudi Arabia, Iraq, UAE and Kuwait. Iran is allowed to raise output by 90,000 barrels as they have sought special treatment as it recovers from sanctions. It is unclear whether the Opec cuts were wholly contingent on the planned 600,000bpd cuts by non-Opec members, including a 300,000bpd cut by Russia. Mr al-Sada of OPEC said the agreement would “definitely help rebalancing the market”, enabling the industry to “come back and reinvest” in new production capacity to ensure future security of supply.

supply-demand-oilIn simple economics this reduction in supply of a very inelastic product should, in theory, increase the price of oil and on the news of the cuts oil prices surged as much as 10pc to hit $52-a-barrel – see graph opposite.

 

Are oil exporters the reason behind the global imbalance?

The Economist ran an article that focused on the global imbalance in the world economy. We have been accustomed to hearing about the USA being great spenders and running large deficits and the Chinese being big savers and running large surpluses. However those that have been running even bigger surpluses are the oil exporting countries which have enjoyed a huge windfall from high oil prices – according to the IMF $740bn of which 60% will come from the Middle East. This compares to China’s suprlus of $180bn.

The Economist stated that only a fraction of this oil surplus has gone into official reserves and therefore hasn’t attracted much attention. A lot the money has been put into equities, hedge funds etc through intermediaries in London. The affect of higher oil revenues on the world economy depends on whether the money earned is then spent on buying goods and services from oil importing countries – this maintains demand and the velocity of the circulation of money in the circular flow. In the oil crisis years of 1973 (400% increase) and 1979 (200% increase) 70% of the revenue earned by oil exporting countries was injected back into the circular flow on purchasing goods and services. The IMF estimates that less than 50% will be spent in the three years to 2012. For each dollar spent on oil from OPEC countries in 2011 there was the following spent on the exports from that country:

USA – 34 cents came back into the economy
EU – 80 cents came back into the economy
China – 64 cents came back into the economy

Normally a large current account surplus would be eroded over time by a stronger domestic spending and a higher exchange rate. However the Gulf currencies are pegged or closely linked, to the US$. The best way to reduce the current account surplus of the oil exporting countries is to increase public spending and investment which might reduce dependence on oil revenues and therefore less likely to become part of the resource curse.

Has OPEC lost its price regulator status?

The Organisation of Petroleum Exporting Countries (OPEC) sell about 30% of the world’s crude oil and has been identified as a price regulator, supplying more into the market as it felt necessary – this has led to accusations of price fixing.

However recent days has seen OPEC’s influence over price diminish. Even when you consider the inconclusive OPEC meeting last week on production quotas, its members were already breaking their quotas putting an extra 1.5 million barrels of oil a day on the market. As you know this should shift the supply curve to the right and therefore reduce inflationary pressures on the price of oil. However for a couple of weeks the price of a barrel of oil has been around US$100. Furthermore when news got out that OPEC ministers were squabbling the market reacted by increasing the price of oil and it seemed to be more concerned about the oil supply rather than the collapse of OPEC.

With the actuality of the global supply and demand it now seems that OPEC has lost control of the oil market. It transpires that the OPEC meeting broke down mainly because Iran and others hindered a bid by Saudi Arabia and its Gulf allies to increase output at a time of world economic weakness. Rejecting the rise keeps oil prices high which helps Iran’s bank balance as well as having a negative impact on any recovery from the US economy.

The Iran led opposition to rasing output was about “sticking it to the Saudis and psychologically sticking it to the US”

Here is a clip from AlJazeera

Libya and world oil

In 2008, at the height of the financial crisis, a barrel of oil reached $147 and amidst the turmoil in the Middle East there are concerns that this figure will reach over $200 a barrel. If this transpires there is a real risk of a double-dib recession especially in the US and Europe – if not New Zealand. In Libya, as rebels took control of the port of Tripoli its critical oil supplies remained squeezed, production from most of Libya’s oil fields was down to very low levels. The country’s wealth largely comes from oil and whoever controls the oil fields will ulitmately control the country.

Libya in the Global Oil Market

The Economist website has some good statistics about the oil industry. Libya sends 1.4m barrels/day to global markets which is around 2% of global demand. This makes Libya the thirteenth largest oil exporter. Saudi Arabia the worlds biggest exporter, and country with significant spare capacity, is already pumping an extra 600,000 barrels per day to make up for the shortage on world markets.

A recovering global economy had convinced traders that demand for oil was going to rise by about 2 percent in 2011. Some industry experts and Wall Street visionaries were predicting a gradual return to $120 and even $150. The thinking was that investors would pour money into the commodity markets. This was due to the huge increase in demand from developing countries which was threatening to obliterate OPEC’s spare capacity – see graph below.

If prices keep climbing, consumers will in all likelihood tighten their belts. If prices stay high for long, the impact could be severe: every oil shock of the past 40 years has helped push the global economy into recession. Nariman Behravesh, senior economist at IHS Global Insight, said that every $10 increase in the price of a barrel of oil reduces economic growth by two-tenths of a percentage point after one year and a full percentage point over two years – New York Times.

However, as the world is so dependent on oil there is little room for supply disruptions. Spare capacity is at 5 million barrels a day which is approximately 6% of what the world consumes every day. Although this is 4% higher than in 2008 it is still worringly low when one considers the demand pressures coming from developing countries like China and India. However that is not even taking into account the loss of about one million barrels a day exported from Libya. If Libyan oil was to be removed from the oil market it would represent the 8th largest oil shock in history – see graph below.
Much now hinges on what happens next in the Middle East. The price spikes that accompanied the two Persian Gulf wars did not have deep impacts because of they did not last long enough. But several oil price increases have preceded economic downturns. The biggest shock followed the 1973-74 OPEC embargo, which quadrupled oil prices and helped produce stagflation, a period of slow growth, high unemployment and inflation. The 1979 Iranian revolution caused another shortage, and again American motorists were forced to wait in long lines for gasoline. Oil prices surged, but they did not stay elevated for long, as Mexico, Nigeria and Venezuela expanded production and OPEC lost its unity. Oil prices remained low for years, and the economy through the later half of the 1980s and most of the 1990s was generally strong. New York Times