Since last year, the price of Brent oil has dropped from $100 to its current value of just over $40. Although cheaper oil is often hailed as a boost for the world economy, it will have an affect on economies which are reliant on oil.
The current black Monday crises also is closely related to the price of oil.
Last year, in late 2014, Saudi Arabia started flooding the market with cheap oil. With the biggest oil reserves, low drilling costs and a huge financial reserves, Saudi Arabic can ‘afford’ to do this.
Political commentators suspected that the flooding of the market was designed to hurt the Russian economy and at the same time scupper the shale production in the United States.
Although it has been disputed by Saudi Arabia that they wanted to hurt the Russian economy, it appears that their biggest fear was from new competition, as pointed out by the Saudi Prince Alwaleed bin Talal in a recent USA Today interview:
“Shale oil and shale gas, these are new products in the market. And we see big ranges. No one knows for sure what price is the breaking point for shale. Wells have a higher production cost. And very clearly these will run out of business, or at least not be economical.”
Constructing the shale plants and refineries cost billions and require a oil price of over $80 per barrel to recoup the costs of drilling and generate revenue. The wells were funded and built on a projection of $100 per barrel of oil.
Saudi Arabia would need to keep the cheap oil price down for at least a year to ensure that the market for Shale oil collapses once and for all.
The Prince claims, “So although we are caught off guard by this [price drop], we are capitalizing on this matter whereby we’ll live with $50 temporarily, to see how much new supply there will be, because this will render many new projects economically unfeasible.”
If this is indeed the strategy then we can expect the low oil prices to continue.
Water off a … bear’s back
Recent details from BNP Paribas indicate that the low oil price would only affect Russia’s GDP by a mere 2%.
The low oil price has impacted countries like Oman the most along with Venezuela and Gabon. The drop from $100 to $80 is expected to impact the Omani GDP by almost 10%.
Oman’s economy relies heavily on oil. Crude oil and accounts for well over half of Oman’s exports – of which a third go to China. China’s growth expectations have just been readjusted down and demand for oil from the Chinese, European and Japanese has also dropped.
Analysts expect that the price drop won’t, however, affect UAE, Qatar and Kuwait as badly since, according to BNP Paribas, the losses can be offset with fiscal stimulus.
The Dollar relationship
Many Gulf countries including Saudi Arabia, Oman and UAE have pegged their currency to the dollar. Considering that their biggest export was oil – which is traded in US Dollars, this made a lot of sense.
Countries would need to buy Petrodollars in order to trade oil, regardless of with whom they trade. This arrangement has benefited the United States incredibly because it ensured the US Dollar became a de factoreserve currency. The additional dollars were usually reinvested into financial products.
This arrangement may now be coming to a close. Many countries, particularly the BRIC group of countries are starting to enter bilateral trade agreements and therefore trading in either their own currencies or other currencies, such as Euro, Yuan and Rouble.
As result, less Petrodollars are being ‘created’ and thus less liquidity is entering the financial markets. The drop in liquidity has had an impact on the latest crisis.
If countries are no longer trading in US Dollars, then they can also opt to devalue their currency in an attempt to offer their exports cheaper.
Kazakhstan has just de-pegged its currency from the US Dollar. The Kazakh Prime minister then gave this startling insight during a Bloomberg article:
“At the end of the day, most of the oil-producing countries will go into the free-floating regime,” including Saudi Arabia and the United Arab Emirates, Karim Massimov said in an interview on Saturday in the capital, Astana. “I do not think that for the next three to five, maybe seven years, the price for commodities will come back to the level that it used to be at in 2014.”
The depegging and devaluing of the currency would also, for example, benefit Oman’s floundering tourism industry which has also been affected from the strong US Dollar relative to the Euro. Since a large percentage of tousrist come from Europe, Oman is now an expensive destination.
Depgging from the US Dollar is not only a economical decision, it is also a political move and individual countries will want tread carefully. If more momentum does gather regarding the bilateral trade agreements for oil and further countries depeg from the US Dollar then this could be a tide that the Americans cannot stop.
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