Falling Oil Prices Could Give West Upper Hand

As prices drop to well below $70 a barrel, ripples are being felt from the Kremlin to Iran.

Bloomberg

If there was one piece of news the main oil exporters did not need, it was the announcement on Tuesday that after long years of often acrimonious negotiations, the Iraqi government had signed an agreement with the Kurdistan Regional Government on the division of the output of the oil fields in the Kurdish areas on Northern Iraq. The Kurds agreed to send 300,000 barrels of oil a day south through the Iraqi pipeline while being allowed to independently sell on the international market 250,000 barrels of their own through a different pipeline to neighboring Turkey. 

The agreement was reached largely due to the ongoing fighting with the Islamic State (ISIS) which led to the collapse of the Iraqi army and the re-emergence of the Kurdish militia Peshmerga as the dominant force in the north.

The Baghdad government is no longer capable of preventing the Kurds from exporting their own oil and had no choice but to sign the agreement, opening up the way for the entrance of Western oil companies eager to develop new oil fields in the region. A new source of cheap available oil added to the growing global surplus. The markets were quick to react with another dip in the price of oil, now hovering at around 65 dollars, the cheapest in over four years.

The forecast of $200 a barrel

A year ago, the accepted narrative in the West was that an imminent war in the Middle East, particularly between Israel and Iran, will push oil prices sky-high, causing a global economic crisis. Oil was selling at $120 per barrel and there were analysts who wouldn’t rule out the possibility of it reaching $200. The Mideast oil producers were not the only ones well served by this scenario. The Russian economy was going through a decade-long boom allowing Vladimir Putin’s Kremlin to enlarge subsidies, social transfers, government salaries and embark on massive development programs including the exorbitant Sochi Olympics. Other countries with oil-based economies such as Venezuela were also in the ascendant. After the Fukoshima disaster in 2011, with many countries scaling back plans to invest in nuclear energy, it seemed that the world’s dependency on oil would only increase. In recent months, this trend has been totally reversed. Just in July, oil still sold at around $100 per barrel. Now, just four months later, it is well under $70.

Many factors contributed to the change. The slowdown of the Chinese economy, one of two largest consumers of oil, while at the same time the United States drastically reduced its dependence on foreign energy sources, partly due to larger use of alternative energies but largely to the expansion of the shale oil industry. America’s neighbors have also greatly expanded their oil production; Canada, through the development of tar sands extraction and Mexico, by finally allowing foreign oil companies to develop its offshore fields. To this can be added the shift by many countries to using liquefied natural gas being found in various places around the world.

Last week in Vienna, as the negotiating teams which failed to reach an agreement on Iran’s nuclear program left the Austrian capital, the OPEC oil ministers arrived there for an emergency meeting to discuss the plummeting prices. This summit was also unsuccessful. Some ministers demanded a cut in output in a frantic attempt to stem the flood but the stronger members, Saudi Arabia and the Gulf states, refused.

OPEC’s failure only strengthened the descent. The weakness of the oil cartel is the first geopolitical shift in years which could give the Western nations the upper hand in a series of tension-spots. It remains to be seen whether their leaders will exploit this.

Russia’s shrinking economy

Putin restored order to Russia after the period of near-anarchy under Boris Yeltsin in the 1990s. The Kremlin retook control of the state’s energy resources and used the growing income to prop up the regime by raising salaries and pensions of tens of millions of employees in the public sector. The crashing oil prices coupled with the economic sanctions imposed by the West following Russia’s invasion of Crimea and eastern Ukraine are now causing a recession. Instead of a forecasted 1.2 percent growth in GDP, the Russian economy is now expected to have shrunk by nearly a point this year.

Rising consumer prices and the closure of markets in the West is impacting on the average income of Russian citizens who are also fearing that the rapidly devaluing rouble could wipe out their savings. Putin on Thursday in his annual “Nation Speech” blamed the West for trying to stymie Russia’s growth, even comparing the West’s policy with that of Hitler, and promised Russia would persevere. But even he acknowledged the dire situation when he offered “amnesty” to Russian businesspeople who in recent months have transferred at least 100 billion dollars of assets out of the country. 

So far the main reason that Putin succeeded in blocking the pro-democracy movement was not the iron hand with which demonstrations were dispersed but the confidence most Russians had in the economy remaining stable under Putin. With the erosion of that confidence, it will become more difficult for Putin to continue provoking the West by undermining the former Soviet republics trying to free themselves of the Kremlin’s orbit. Putin could risk adventures in Ukraine, Georgia, Moldova and the Baltic states only as long as he could rely on calm at home.

Another blow to Russia’s standing last week was the decision by Putin to cancel the South Stream pipeline designed to bypass Ukraine and stream natural gas to western Europe. The cancellation is a result of a shortage in cash and also European Union plans to find new energy sources, including purchasing gas from the United States, Iran and Saudi Arabia.

Iran’s dashed hopes

Over the last week and a half, Iranian leaders have been optimistically predicting that a nuclear agreement will be signed very soon. This is a thin façade covering the panic in Tehran’s markets over the drastic devaluation of the rial and the rise in bread prices. Iran’s oil-dependent economy is already paralyzed by the nuclear-related sanctions. To balance its budget the government needs oil to sell at $130 a barrel. As it is, the sanctions have already pushed Iran’s ranking among the oil-exporting nations from fourth place to eighth.

Iran clung to the hope that OPEC would cut output, pushing the prices back up. With its hopes dashed and the nuclear talks still unresolved, unless the West make more concessions in the next rounds of talks, the tension between Iranian politicians in favor of reestablishing relations with the West and the hardliners prepared to risk even greater financial hardship to keep the dream of a nuclear weapon, will greatly intensify, together with a greater potential for food riots. Iran will also have less ability to continue supporting its regional allies, the Assad regime in Syria, Iraq’s Shiite government (also suffering from the low oil prices) and Hezbollah in Lebanon.

On the other side of the Persian Gulf, the Saudis who have already lost their primacy as number-one oil producers to the Russians and then the Americans is also hurting. It’s budget is based on a $106 per barrel. But, unlike Iran and Russia, its oil infrastructure is in a relatively good state and it holds a massive reserve fund of $800 billion accumulated during the heady years. The Saudi refusal to cut output is an acknowledgment that OPEC no longer controls the energy market, but it is also prepared to lose money in the short-term as long as its major Shiite rival, Iran, is hurting much more.

Ripples in Venezuela and Scotland

The regime of President Hugo Chavez relied on nationalization and using the oil money to finance the populist-socialist-Bolivarist fiscal plans. But despite Chavez’s promises to develop a diverse economy, industry and infrastructure, Venezuela’s fortunes remain reliant on the price of oil and under his successor Nicolas Maduro, the growing deficit is already causing shortages of food and other goods that it can’t produce for itself. Dozens of citizens have already been killed in violent demonstrations which are set to get worse.

Under Chavez, Venezuela generously supported other nations in Latin America which adopted his strident anti-Americanism and propped up Cuba’s weak economy. Maduro won’t be able to do the same; he will find it difficult to cling to power in his own country.

Another ideology which could suffer from the plunge in oil prices is the Scottish Nationalist movement which lost an independence referendum two months ago but is still demanding to secede from Britain. The economic plan upon which the case for independence was made was based on the income from the North Sea oil boosting the Scottish economy, but the calculations were made with a barrel selling for over $100. The nationalists will find it difficult now to convince Scots of their ability to prosper outside of Britain.

Energy analysts are finding it difficult to predict how long oil prices will continue to go down, and how low they will drop. At some stage, demand will increase again as the global economy emerges from recession. Lower oil prices will prevent some of the producers from investing in infrastructure and developing new oil fields, which could cause shortages. In addition, if oil goes below $50 per barrel, it will make shale production in the United States, which was only worthwhile due to high oil prices, no longer profitable (by comparison, in the Middle East, where oil is easily accessible close to the surface, a barrel costs on average only five dollars to produce). All these factors could lead to an increase in oil prices again but that will probably take a few more years. Some of the regimes which rely on oil may not survive that long.