18 Feb 2016

Are oil prices a threat?

Brian writes*

Oil prices have taken quite the tumble in the last 18 months. Falling about 75% from the $110 per barrel mark to $27. One might consider this to be highly beneficial from a consumer’s perspective. But, of-course the ripples of this oil shock are more far reaching then initial observation might communicate. It might seem as though the time has come for some oil producers to start “plugging their wells”. However, this would be to the detriment of the future rebound in oil prices. The benefits of which would go to those that have chosen to keep their oil production steadily flowing as long as they can cover costs.

The ripple effects of oil price drops can have lasting consequences on several levels. Firstly, it brings the possibility of political instability to already unstable parts of the world. Secondly, cheap oil makes it a very easily accessible source of energy. Exposing the world to more consumption and thus excretion of fossil fuels to the detriment of our increasingly suffering environment. Rendering an already threatening negative externality even more harmful as the spillover cost on society is ramped up. Thirdly, the steep drop in oil prices has caused a tumble in investment in the industry. Projects worth up to $380 billion have been put on hold. Countries such as Brazil are grappling with these effects because the oil industry is such a prominent component of the national economy. Saudi Arabia is also dealing with a increasingly threatening deficit.

The Main issue currently faced by the oil market is a production surplus in oil. The low prices are maintained by a production surplus, keeping the market over-flooded with oil. As this is happening, the consumption and production of oil rise to meet each other. In other words, the increased demand requires an increased supply. In order for the negative externalities, from dropping prices and increased oil consumption to be stemmed, the oil cartel OPEC must halt the oil shock. Something that they seem to be unwilling to do. If production is cut down, the prices can be stemmed. Hopefully halting economic strain. It is suspected that there is a possibility of political will behind this refusal. Primarily the drive of the United States and the Saudis to hurt the Iranian and Russian economies.  In the process, the effects are globally felt and threaten different economic facets in a wide range of countries.

Bottom Line High oil production has decreased oil prices, causing a surplus that has a wide range of negative externalities on an international scale.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.


Felipe van de Kerkhof said...

Interesting read!

I agree that high oil production (and cheap price) probably displaces other sources of energy production. However, the energy market is not as simple as that.

First, a reliable, cheap 'back-up' energy source might be very beneficial for the production of renewable energy as the total price for electricity won't have to fluctuate much. It could make up for Renewable energy's biggest flaw: we can't store it anywhere, so it should be used immediately after production.

Secondly, the low prices of oil, could allow governments to radically change their energy policies with less harm to their economies. This was argued in this (http://www.economist.com/news/leaders/21639501-fall-price-oil-and-gas-provides-once-generation-opportunity-fix-bad) Economist opinion piece from January 2015 (when the consequences of low oil prices came to be known).

All in all, I really like your blog post and it's a good starting point to look at the very multi-facetted energy debate

Federico Brovelli said...

The topic of your article is interesting and I agree with your arguments. There are just some consideration that I would like to make.
First of all, the decrease in oil price is also caused by the low global economic rate that we are facing in the past years and therefore having a lower demand, but you are right: It has mostly to do with the oil surplus.
It would be more interesting to examine why oil producing countries would not want to decrease their supply in order to try to push prices back to a "equilibrium point". I am not quite sure about the theory of hurting the Russian and Iranian economy as Saudi Arabia is making heavy losses due to the low oil price. For instance, the Russian Energy Minister Alexander Novak stated that they would not cut oil production out of the fear that it will incentivise importer countries to look for alternative sources or start to produce oil on their own. It is clear that a low oil price is damaging to oil exporting countries (even the US who just recently started to export oil again), but this could also be an opportunity to finally start to diversify their economies, something that countries like Saudi Arabia has long postponed. Finally, Europe’s flagging economies, which have low inflation and weak growth, would benefit from the low oil prices. Japan, a country that imports all its oil, can more easily combat its fear of deflation and also India can combat its current account deficit.

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