Oil glut and world economy (The Frontier Post (Pakistan))

Global oil prices started declining in June 2014 and continued to plummet till today leading to significant revenue shortfalls in many energy exporting nations. Saudi Arabia, UAE, Nigeria, Venezuela, Iran etc are the losers; whereas China, Japan and Asian countries that depend heavily on import of oil stand to gain. American consumers are indeed the largest beneficiaries of decline in oil price, as they are today buying petrol at $2.05 per gallon against $4.06 a gallon since 2008. This will result in savings on their fuel for cars and heating their apartments. They are likely to spend this amount on buying new cars and other electronic gadgets, which will give boost to the production and create employment opportunities offsetting the lost jobs in oil sector. Of course, consumers in many importing countries are paying less to heat their homes or drive their cars. From 2010 until mid2014, world oil prices had been fairly stable, at around $110 a barrel. But oil has now dipped below $50 a barrel for the first time since May 2009 and US crude is down to below $48 a barrel, thanks to boost in shale oil.
Asian countries stand to gain in many ways. For one, it will help control inflation; secondly, countries like Pakistan can balance their budgets by reducing subsidies, which will help meet IMF condition for keeping the fiscal deficit within given parametres. Thirdly, because of their lower oil import bills trade deficit would be less. Pakistan has passed only a part of the benefit accruing from declining oil prices to the consumers. In fact oil price mechanism has not been logical since 1970s, as oil producing countries and international companies have been fleecing the developing countries because of surge in oil demand in the global market. Now the global demand for oil is weak because of static European and American economies. Even China’s economy, which registered around 10% economic growth for a decade, is down to 7 to 8%. On the supply side, the unconventional technology that enabled producers to extract oil from shale triggered a boom in American energy.
However, in case of further decline in oil price, American producers won’t be able to compete with the megaexporters in the Middle East, who would remain competitive and continue to be in a comfortable position because of lower cost of production. Cost of production of shale oil varies from area to area and from well to well, which is $50 to 75, on the average North American shale development needs a US crude price of $57 a barrel to break even today. The reason is that horizontal drilling and hydraulic fracturing is expensive. On the other hand, cost of production per barrel in Middle East on the average is around $27, and with 20 per cent profit and 10 percent transportation cost, they can afford to sell at $40 per barrel. Since the 1973 OPEC oil embargo, oil producers have made fortunes for years, as they had windfall profit of $40 to $80 per barrel. Rulers of the Middle East countries have ostentatious living style; of course they spend a part of it on social sector to keep their citizens satisfied.
It appears that OPEC countries are poised to compete with the US Shale industry, which is braced for a test of endurance. There is a perception that weak companies in the US would face the threat of dwindling investment, faltering production, forced asset sales and possible bankruptcy. The successful companies of course will be the ones that are most effective in improving their efficiency, and will continue to be a threat to the OPEC producers. The question is why OPEC didn’t reduce quotas at its meeting in Vienna on November 27 Perhaps it is wellconsidered strategy of the OPEC members who wish to bring the oil prices to the level where it will be difficult for the American shale producers to continue their production and invest in new production. If shale oil producers can compete with the OPEC producers at $50 per barrel, the latter’s economies will be adversely impacted.
It means that chances of windfall profits for oil producers are slim, and Arab countries will have to review their budgets and abandon their ostentatious living styles. The downside is that overall demand for equipment and consumer goods from developed countries would decline in Arab countries and elsewhere. And they may resort to downsizing, and thousands of expatriates will have to go back home. If that happens, economies of the manpower exporting countries like Pakistan would be adversely impacted. It means remittances from expatriates Pakistanis would decline, and Pakistan will lose foreign exchange it saves on oil import bill. That point besides, further decline in world oil price would put the world economy at risk.