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WHY ARE OIL PRICES FALLING?
SHAAN FYE CONTRIBUTORS, ECONOMY, MIDDLE EAST, NEWS, POLITICS, RUSSIA, SHAAN FYE, WORLD NO RESPONSES OCTOBER 20, 2014
BY: SHAAN FYE, EDITOR-IN-CHIEF
What could be a temporary boon for consumers could be indicative of upcoming global economic peril.  WTI Crude oil prices have dropped down to about 82 dollars, the lowest price seen in over two years.  As prices continue to fall, consumers at gas pumps around the country are seeing the price of gas begin to flirt with the 3 dollar mark.  Nationally, the price of gas is 13 cents lower than the price last year and and is at its lowest point since Nov. 22.  What fails to make sense to the average consumer in America is why these lower prices are painting a bleak picture for the current state of the global economy.

LOW GLOBAL DEMAND
The lower prices stem from lower global demand.  In Germany, exports in August are down by 5.8% from the previous month.  This is the biggest monthly decline since the 2009 recession.  The reduced growth forecasts for the German economy underscore an anemic Eurozone.  Slowing growth in the drivers of the Euro – Germany, France, and Italy – have led the European Central Bank to relax monetary policy, cutting interest rates to below zero percent and engaging in a European-style Quantitative Easing program.  By doing this, the ECB hopes to combat deflation as well as making exports more competitive for the European economies.  It remains to be seen whether or not these drastic measures will positively affect export-driven Germany.

“There are definitely some headwinds on the market right now and they’re coming out of Europe,” Erik Davidson, deputy chief investment officer of Wells Fargo Private Bank, told the Associated Press.  These headwinds will hurt demand throughout the entire continent, lowering prices further.  However, the lack of growth is not limited to Europe; China is also driving oil prices down with its reduced economic forecasts.

In China, a decline in consumer inflation has the potential to slow down the behemoth economy.  Lower consumer inflation numbers mean the profit margins of Chinese businesses will shrink while still having to pay the same interest rate on debt.  The lack of consumer price index growth is intensifying concern that China will not reach its 7.5% GDP growth target this year.  The impending Chinese slowdown will deleteriously affect global oil prices temporarily until a new equilibrium can be established.

A positive feedback loop is establishing itself as the United States continues to show strong economic indicators.  Because oil is priced in U.S. dollars, the strengthening of the dollar (a reflection of the economy) will further dry up demand in other nations as oil prices become more expensive outside of the United States.  A stronger dollar means lower demand in foreign countries on top of already weakening growth.

OPEC VS. THE U.S.A.
Lowered demand from these two areas of the world is not the only concern; OPEC is concurrently falling into a price war as members continue undercutting each other to preserve market share in Europe and Asia as US exports look more and more competitive.

“Saudi comments indicate that it may have shifted from a strategy of holding prices at around $100 a barrel to a focus on market share,” said Jeff A. Dietert, head of research at Simmons & Company, an independent investment bank. “That means there is not an immediate floor on oil prices.”  Saudi Arabia and others in its vicinity are showing that they are increasingly willing to let prices fall to maintain competitiveness in non-U.S. markets as U.S. domestic production reaches 8.7 million barrels a day, cutting OPEC imports in half since 2008.

The United States forecasts record shale exports for November as well as the highest domestic supply since 1986.  Unfortunately for America’s competitors,, the shale floor has not been broken through yet.  Maria van der Hoeven, executive director of the International Energy Agency, estimates that 98% of oil exports in the U.S. have at least a breakeven price of 80 dollars, and that 82% have a price below 60 dollars.  Only about 4 percent of U.S. shale output needs prices above 80 dollars; the future of shale is still in the green (or black).

The U.S.’s increasingly competitive oil industry is beginning to put the country at odds with OPEC countries, potentially straining strategic relationships vital in pursuing American foreign policy in the Middle East.  Self-reliance may end the insider relationship the U.S. currently enjoys with the Saudis and Qataris to name a few.  This may complicate U.S. Foreign Policy in the Middle East.

SAUDI ARABIA VS. RUSSIA
Saudi Arabia’s actions indicate that it wants to test the shale break-even price as well as crowd out its oil producing adversaries – Iran, Syria, and Russia. Unlike Saudi Arabia, these countries have budgets dependent on oil as high as 100 dollars a barrel, as in Russia’s case.

Saudi Arabia, by doing this, hopes to reverse Russian policy concerning the Syrian Civil War.  While Russia requires one hundred dollar oil prices for their budget, the Saudis can get away with $83.60 a barrel to balance its budget.  At the same time, the central bank has $734.7 billion in reserve assets according to the International Monetary Fund said.   The Saudis, unlike their OPEC counterparts and Russia, are in the best position to weather the bearish oil outlook, and may be prepared to do so over a myriad of issues, including the situation in Syria.

“Lower oil prices completely overshadow the encouraging news from southeastern Ukraine,” says chief Russia economist Dmitry Polevoy of ING Bank, regarding the Russian pullout of troops from Ukraine recently, Businessweek reports.  Russia will encounter a significant budget deficit this year, provided that oil prices do not dramatically rise, considering 45% of the government’s revenue stems from oil taxes.  This has (and will continue) to hurt the Rouble’s value, adding to the pressure from sanctions.

If Russia continues its support of the Assad administration, it would not be surprising to see Saudi Arabia further slash prices in an attempt of economic warfare.  The fight over Syria is essentially a proxy war, both sides arming, funding, and training either the Free Syrian Army or Bashar Al Assad’s regime.

THE EFFECTS OF SUSTAINED LOW PRICES
The unrest currently plaguing the world has led to this situation and has the potential to worsen it as well.  One worry is that the fall in oil prices will lead to increasing acts of desperation by those countries affected, potentially provoking countries like Iran and Russia.  The oil glut also has the potential to hamper the outlook of renewable energy development around the world as it looks less and less cost-effective in the face of sub-100 dollar oil.  The sustained downturn of prices directly threatens the newly significant portion of America’s economy, fracking.  Although the prices would have to fall further, there is no indication that countries, especially Saudi Arabia, would take a temporary hit to ensure long-term dominance.  Oil prices have a clairvoyant tendency to foresee economic outlooks.  If this recent downturn is any indication, last week’s market selloff is only the beginning.

For questions, comments, or concerns, please contact Shaan Fye at shaanfye@atlasbusinessjournal.org