Falling Oil Prices Impact a Lot More Than Your Wallet
Saudi Arabia’s powerful oil minister made a very strange comment on December 22. He told the Middle East Economic Survey that it was “not in the interest of opec producers to cut their production, whatever the price is” (emphasis added throughout).
“Whether it goes down to $20 a barrel, $40, $50, $60, it is irrelevant,” the kingdom’s Oil Minister Ali al-Naimi said.
His odd comments come as the price of oil hits multiyear lows.
Since June, United States’ crude has cascaded from $107 per barrel to $56 per barrel. The sell-off in Brent Crude, the oil purchased by Europe and Asia, is even steeper. It has plummeted from $112 per barrel to $61. Just a few years ago, oil traded for $140 per barrel.
It is the third-sharpest decline in history, yet the Saudis seem to want it to go even lower. This is strange because the Organization of the Petroleum Exporting Countries (opec) cartel was founded to do just the opposite—keep oil prices high by limiting supply.
Something smells rotten—and it isn’t the sulfurous crude bitumen produced by Canada’s oil sands.
So what are the Saudis up to? And how will it impact you?
The United States—the Good and Bad
It impacts you every time you head to the gas station. That is the good news. According to Citigroup, if these prices hold, the average family will save $1,150 over the course of the year.
The extra cash is an immediate boost for the economy. The U.S. Bureau of Economic Analysis (bea) reported on December 23 that U.S. gross domestic product grew at a barn-burning 5 percent rate during the past quarter. This was the fastest growth since the economic crash in 2008. Even if the bls numbers provide a poor measure of the real economy, expect the Christmas shopping numbers to be good for retailers this year.
Yet there are also risks to America’s economy that did not exist in America just a few years ago.
You may not realize this, but in the years following the 2008 Wall Street meltdown, shale oil revolutionized America’s economy. And last year, according to Bank of America analysts, the United States overtook both Saudi Arabia and Russia to become the world’s largest oil producer.
This radical development was made possible by fracking technology. It allowed companies to get oil from shale rock. The same technology allowed America to become the world’s largest natural gas producer in 2010.
Massive amounts of previously inaccessible energy helped power America’s economy in the post-2008 crisis.
The shale oil and gas revolution has been the nation’s biggest single creator of full-time, middle-class jobs since the 2008 economic crash. As economic analyst John Mauldin points out, nearly 1 million Americans work directly and 10 million indirectly in the oil and gas industry.
“The important takeaway is that, without new energy production, post-recession U.S. growth would have looked more like Europe’s—tepid, to say the least. Job growth would have barely budged over the last five years,” Mauldin says.
But America’s energy boom was predicated on oil prices that no longer exist.
The average mid-cycle break-even price of a shale oil company operating in the North Dakota’s Bakken field is $69 per barrel, according to analysts at Scotiabank. The break-even cost in the Permian Basin in Texas comes in at $68 per barrel. The Niobrara at $59. And the Eagle-Ford at $50.
Remember, these are mid-cycle break-even prices that don’t factor in the upfront costs of acquiring the land and infrastructure. You need to tack on an additional $5 to $10 per barrel for those costs.
Today, that oil can only be sold for around $56 per barrel.
Houston, we have a problem.
The vast majority of America’s newest oil production—the production that has powered so much of America’s recent job growth—is uneconomical at current prices.
Existing oil wells will continue to be pumped because companies have no other choice, but future development will grind to a halt.
Already, Reuters reports that well permit applications were down 40 percent in November. And it wasn’t until December that the oil price really started falling.
Layoffs at drilling companies are starting too.
Making matters worse, America’s oil boom was financed by extreme debt. This may be the bigger danger for America.
“The reality is that the recent energy boom was financed by $500 billion of credit extended to mostly ‘subprime’ oil companies, who issued what are politely termed high-yield bonds—to the point that 20 percent of the high-yield market is now energy-production-related,” writes Mauldin.
“High yield” is code for junk.
A “subprime” oil crisis may be looming. If so, shale oil companies and the banks that lent to them will be ground zero. Your 401(k) or pension plan will be the aftermath. And the poisoned fallout will radiate throughout the economy.
“Losses are going to cascade through the system,” says former cia financial analyst Jim Rickards. “There are unforeseen consequences and hidden losses. I am not so sanguine that this is going to work out so smoothly in the end …. This looks like the beginning of [a crisis].”
These wild gyrations in the price of oil have real-world effects on world economies. Everyone in the sector is stung.
North and South of the Border Not Much Better
In Canada and Mexico, two major oil exporting nations, the lower oil price is also a mixed blessing.
In Canada, the oil sands have among the highest all-in-cost of production—even higher than U.S. shale oil. The advantage Canada has is that oil sands operations are more like mining operations. Once the mines get built, they produce the oil relatively inexpensively for up to 30 years or more. So even with prices so low, the oil will continue to flow. However, new projects will be put on hold. In contrast, shale oil wells produce about 90 percent of their oil their first year and run dry after three years. So if oil prices don’t improve quickly, these U.S. based competitors will be the first to go bust.
Oil producing provinces like Alberta, Saskatchewan, Manitoba and Newfoundland will be hit the hardest. Provincial collections will be smaller than expected.
In Mexico, the low oil price could hit home with a devastating punch. The energy sector accounts for a full 13 percent of Mexico’s economy. Much of Mexico’s oil production is pricier Gulf oil which comes from aging oil fields. The longer prices stay low, the greater threat these fields will come under. Additionally, oil accounts for 32 percent of government revenue—and the Mexican government has based its 2015 budget on an average price of $79 a barrel. Lost jobs and reduced government spending could lead to growing social instability.
But as important as oil is to North America, taken together, Canada, Mexico and the United States are not only close to energy self-sufficient, but close allies.
The same cannot be said about the rest of the world. Plunging oil prices, while an economic blessing to some nations, threaten to collapse others.
The falling oil price might even mean war.
Here is a brief summary of the most important considerations from several oil-tension points around the world.
opec: The Biggest Loser Is?
You can’t discuss oil prices without considering the world’s premier oil cartel.
For several of these member nations, oil is a matter of life and death. The International Monetary Fund in October analyzed the oil prices various government’s need to balance their budgets. The nations on the Arabian Peninsula (Saudi Arabia, Kuwait, the United Arab Emirates and Qatar) can survive with $70 per barrel oil. These nations also tend to be the ones with the largest financial reserves. According to one estimate, Saudi Arabia could survive for two years at these prices with minor difficulty. These low-cost opec producers may even benefit in the longer term from lower oil prices.
Depressed prices shake out the competition. If oil prices stay low long enough, production from old, less profitable fields and new, expensive fields may be shut in. Once closed, the costs to reopen can require much higher oil prices to be economical. Additionally, low oil prices will begin to suppress alternative energy sources as well. When companies go bankrupt, plants and equipment get neglected, supply chains break down, and it becomes more difficult for industries to start back up again.
Some analysts, including those quoted by the Wall Street Journal, have speculated that the Saudis desire to drive prices lower was specifically targeted at U.S. fracking companiesthat are responsible for almost the entire increase in global oil production over the past five years. On November 3, the wsj quoted Saudi sources saying they would sell oil to America for less than their Asian customers. So it is possible that U.S. production was a target of the Saudis, but it is more likely the sheiks had other targets in their sights.
Consider which opec nations are the big losers.
“Saudi Arabia, U.A.E. and Qatar can live with relatively lower oil prices for a while, but this isn’t the case for Iran, Iraq, Nigeria, Venezuela, Algeria and Angola,” said Marie-Claire Aoun, director of the energy center at the Institute for International Relations in Paris. “Strong demographic pressure is feeding their energy and budgetary requirements. The price of crude is paramount for their economies because they have failed to diversify.”
Iraq, Nigeria, Venezuela, Algeria, Angola and Libya are all considered Iran’s opec allies. And bitter enemies of the Saudis.
These nations all need $100 per barrel oil or higher to balance their budgets. And of these nations, it is thought that Iran is the most vulnerable to falling prices. A 2009 estimate put Iran’s break-even cost of its oil production at $90 per barrel.
It is likely that Iran is a target of the Saudis move to depress oil prices.
If this is the case, one of the biggest impacts from Saudi Arabia’s decision to keep pumping oil may be the fracturing of opec. Divisions between the low-cost oil producing nations led by Saudi Arabia and the high-cost producing nations led by Iran will become increasingly stark.
Budget pressures in Iran, Libya and Algeria could soon lead to crisis situations. For a preview of what may be in store for the people of these nations, just look at Venezuela where social welfare spending is being slashed, inflation is destroying people’s savings, store shelves are empty, violent rioting is widespread, and revolution—as opposed to tar sands fumes—may be in the air.
Expect falling oil prices to also empower the radicals.
In Nigeria for example, a weakened government will be less able to resist the Muslim Boko Haram terrorists pushing toward its city centers. Expect more #BringBackOurGirls hashtags.
In Libya, watch for the civil war to heat up again as various terrorist groups fight to maintain their share of shrinking oil revenues. The southern portions of Libya especially will be a hotbed for extremists, potentially destabilizing neighboring countries.
Most importantly, watch Iran, the regional kingpin and world’s number one terrorist sponsoring nation.
Iran has one of the Middle East’s toughest armies, its biggest economy, and its second-largest population. It is also locked in a game of nuclear-chicken with the United States and Europe. What will it do to cope with lower oil prices? Will Iran stir up trouble in the Strait of Hormuz, the strategic chokepoint through which 30 percent of all seaborne oil passes? What will it do with Iraq’s oil fields, as it battles the Islamic State for influence in the country? Will Iran activate its agents within the local Shiite population in Bahrain, which is adjacent to Saudi Arabia’s most important oil fields? Or will it take some other radical action to boost oil prices?
Although Saudi Arabia seems to hold oil prices hostage for now, that could completely change if Iran blockaded the Persian Gulf or obtained nuclear weapons.
A desperate Iran will be a very dangerous and unpredictable Iran. Don’t be surprised if it lashes out and reminds some nations who the regional supreme leader is.
The world may not be worrying about low oil prices for long.
Russia: The Bigger Question
Perhaps the biggest question facing the world right now is, what will Russian President Vladimir Putin do?
The International Energy Agency estimates that oil and gas provide 68 percent of Russia’s exports and 50 percent of its federal budget.
Remember how the U.S. government shutdown and gridlock occurred over those miniscule proposed cuts to spending?
Now imagine if the government had to immediately cut its budget by 25 to 30 percent to pay the bills—all the while seeing the value of the dollar evaporate by 60 percent over a matter of months. This is the situation facing Russia. And it comes as Russia’s economy is also being battered by the West’s economic sanctions.
So what will Putin do?
Some analysts, like the New York Times’ Thomas Friedman, have suggested that Saudi Arabia is working in conjunction with the U.S. to drive oil prices down in an effort to bankrupt both Iran and Russia. This is a theme that Putin has also highlighted. As Courcy’s Intelligence Service reports:
Asked about the fall in global oil prices, Putin said: “The obvious reason for the decline in global oil prices is the slowdown in the rate of economic growth … [but] in addition a political component is always present in oil prices … derivatives greatly increasing the volatility of oil prices are being actively used. Unfortunately, such a situation creates the conditions for speculative activity and, as a consequence, for manipulating the prices in someone’s interests.”
On December 18, in his annual speech, Putin said Russia’s existence was on the line: “Sometimes I think, maybe it would be better for our bear to sit quiet, rather than chasing around the forest after piglets. To sit eating berries and honey instead. Maybe they will leave it in peace,” he said. “They will not. Because they will always try to put him on a chain, and as soon as they succeed in doing so they tear out his fangs and his claws. … Once they’ve taken out his claws and his fangs, then the bear is no longer necessary. He’ll become a stuffed animal,” he said. “The issue is not Crimea, the issue is that we are protecting our sovereignty and our right to exist.”
This does not sound like a man ready to concede defeat. It sounds more like a man prepping his nation for action.
The capacity of the Russian people to endure suffering is probably amongst the highest in the world. The Trumpet’s Asia analyst Jeremiah Jacques wrote a fascinating piece on December 24 about how the West grossly underestimates the determination and morale of the typical Russian. His conclusion?
The Westerners who think the current discomfort will be too much for Russians have made a mistake: They have assumed that the Russian capacity to endure suffering and sacrifice in the name of the nation is roughly equal to that of the average Westerner. In fact, it is far greater.
So what will Putin do?
What he is already doing. He will continue to embrace China!
On September 10, China’s state-run People’s Daily Online announced that China had agreed to help Russia construct one of the largest ports in northeast Asia on Russia’s Sea of Japan coast. The seaport is expected to be able to handle about 60 million tonnes of cargo a year—making it as big as Britain and France’s largest ports.
In September, Russia and China also broke ground on the Power of Siberia pipeline. At a cost of up to $70 billion, it is touted as the largest construction project in history. It will unlock additional Russian natural gas fields and tie the two nations closer together economically. In November, Russia and China announced a memorandum of understanding outlining the construction of a second, equally large pipeline that will bring oil to China.
Once these pipelines are complete, Putin will be able to turn off the energy taps to Europe without losing access to customers and their bank accounts.
As dangerous as Europe’s energy dependence on Russia is, it will be multiple times worse in just a few years. This scares Europe’s leaders. Expect a strong push by influential Europeans to repair relations with Russia. Remember, sanctions are a two-way street. And it is Europe, not America, that is bearing the brunt of the sanction pain against Russia.
Russia will also continue its asymmetrical warfare against America. Most recently, as Anthony Chibarirwe wrote: China and Russia agreed to a $24 billion currency-swap program, which will help Russia mitigate the West’s sanctions.
Perhaps more threateningly, Russia has also announced the creation of a money-transfer system outside of the U.S. controlled swift electronic payment system. This is an attack on the dollar’s status as the world’s reserve currency.
swift is the method by which banks transfer money and convert it to dollars for payment. Without access to this system, nations essentially have to revert to barter. In August, British Prime Minister David Cameron publicly asked for Russia to be kicked out of the system. Russian Deputy Finance Minister, Alexey Moiseev promptly responded by saying Russia’s own alternative system would go live in May 2015, if Europe and America followed through. If China, the world’s number one exporting nation, could be convinced to use the Russia system, this could lead to reduced demand for dollars.
The West’s sanctions, coupled with the falling oil price, is driving Russia and China together in a way that otherwise would probably have been impossible.
Geopolitically, this is a game changer.
The last time the world had to deal with a Russia with a secure eastern border was the outbreak of World War ii.
A Russia with its eastern frontier secure makes Putin a very dangerous man.
America’s war on Russia may seem to be working today—but it is actually backfiring. Far from defanging Russia, it is more akin to poking it with a stick. Once the Ukrainian crisis blows over, it will give Putin the freedom to become much more involved in European relations
Keep Your Eyes Open
2015 looks set to be a very portent-filled year. Check back daily as theTrumpet.com works to separate the essential from the clutter to bring you the most prophetically important news. For more information on where the Russia-China alliance is heading, read He Was Right.