Notes on Low Oil Prices and Their Implications

by Miriam R. Lowi | published February 24, 2016 - 9:50am

After about three years of hovering around $110 per barrel, with highs of $125 and lows of $90, oil prices began a precipitous decline in the summer of 2014, reaching a low of $48 per barrel in mid-August 2015 before plummeting to just under $30 per barrel five months later. While investors are no doubt reeling from the impact of this price decline on their portfolios and ventures, it’s well worth pondering how the Middle East and its geopolitics are likely to be affected.

But how to explain this downward spiral in the first place? By all accounts, reasons abound.

Among them: The Organization of Petroleum Exporting Countries (OPEC) chose to drive down the price of oil so as to encourage demand for oil from its member states relative to that from non-OPEC producers. Toward the end of 2014, OPEC took the decision to work to maintain its market share rather than cut production in response to falling demand. This focus on its own share of the oil market is fairly new; previously, OPEC seemed especially concerned to maintain the price of oil within a particular range. (And with that stance as “policy,” Saudi Arabia assumed the role of “swing producer,” tasked with raising or reducing production to maintain the price range.) No doubt, Saudi Arabia was at the forefront of OPEC’s new direction: It is anxious to regain domination of the oil market. And to this end, the kingdom has been keen to push Russia, which is not a member of OPEC, to pump less oil as well.

Be that as it may, analysts insist that another reason is that the supply of oil in recent years has exceeded expectations, due, in part, to the growth in supply of non-conventional oil (from such sources as shale and biofuels), while demand for oil, in an environment of relatively weak global economic growth, has been lower than expected. They add that increased energy efficiency and the declining oil intensity of energy consumption have contributed to the lower demand.

As for the latest fall in prices, some argue that it was prompted by concerns that while the market was already saturated with oil from Saudi Arabia and Russia, it would receive additional supplies from the lifting of sanctions on Iran and the end of the ban on that country’s exports. Needless to say, Iran is unwilling, at this time, to cap its production, having just returned to the global oil market. And despite last week’s agreement between Russia and Saudi Arabia to cut their production, in response to international pressures, nothing really compels them to comply; besides, without the inclusion of Iran and Iraq such an agreement is reduced in efficacy.

Furthermore, the appreciation of the US dollar since 2014 has also pushed down the price of oil. Countries that have experienced an erosion of the purchasing power of their currencies as a result of the strong dollar may respond by curtailing demand.

What about the impact of low and falling oil prices on the Middle East, its international relations and domestic politics? There are likely to be both direct and indirect effects, but much will depend on the duration of the new lows.

Having said that, it is clear that China’s economic growth stands to benefit tremendously from low oil prices. And given that China is the largest importer of oil in the world, it is likely that the ties between Gulf Cooperation Council (GCC) states and East Asian countries, and between Saudi Arabia and China especially, will increase and deepen. Indeed, the Gulf’s eastward turn has been underway for some time, and long-term contracts are bound to grow in number and intensity.

Insofar as regional relations are concerned, no doubt the lifting of sanctions on Iran means that as Iranian oil enters the market, Iran will have the means to be more assertive in the region—precisely what gives Saudi Arabia the jitters. Nonetheless, if low oil prices persist, the growth of Iran’s refinery capacity, and therefore of its exports of refined petroleum, will be constrained somewhat.

For those oil-exporting states engaged in war, persistent low prices are potentially deeply consequential. Yet for Russia (in Syria) and Saudi Arabia (in Yemen) today, they do not yet appear sufficiently consequential.

Both countries built up large currency reserves during periods of high oil prices; both are now drawing down those reserves to sustain spending, fight wars and finance a budget deficit. It was suggested that Russia was approaching the limits of its reserves even before the intensification of Russia’s military intervention in Syria in the fall of 2015. In October, the Russian finance minister told the parliament in Moscow that at current rates of spending, reserves could be exhausted by the close of 2016. As for Saudi Arabia, its reserves remain substantial. While one analyst, Jean Francois Seznec, has suggested that in February 2015 the kingdom had access to reserves from several different sources amounting to a whopping $1 trillion for a total population—citizens and imported labor—of about 30 million, most sources refer to cash reserves of $750 billion. Ten months later, however, reserves had declined to $600 billion. At this rate of spending (and with access to the reserves of a few domestic funds), Saudi Arabia could manage for a few more years, at least. Indeed, the monarchy has shown no disposition to retreat from its devastating war footing in Yemen.

What about the budgetary implications of low oil prices on government spending more broadly? For one, foreign assistance from GCC states to other Arab countries will likely be reduced. But while the relatively poor, non-oil exporting states of the region are bound to suffer, those to whom assistance is closely linked to political expediency will suffer somewhat less than others. (In this regard, it would be interesting to examine changes to the aid package to Egypt from Saudi Arabia and the UAE since the beginning of the presidency of ‘Abd al-Fattah al-Sisi.) At home, ongoing budgetary constraints mean that government spending will have to be reduced. No doubt, austerity is far riskier in Algeria than in (most) GCC states since the per capita cushion of cash reserves is not as generous, while the provision of welfare and social services has been wanting, and popular grievances are manifest. There, the resurgence of relative scarcity and rising frustrations in an impoverished political environment could encourage, as in the past, the mobilization of social forces.

If the price of oil continues to fall and/or remains low, the creation of job opportunities (for the growing numbers of unemployed) will be even more difficult (in the short term, at least) than it has been, while subsidies extended to citizens will have to be reduced, to varying degrees. The GCC has already publicized the decision to introduce, for the first time, a value-added tax, to become operational within the next few years. Were low prices to persist, if not continue to fall over the longer term, domestic politics could be affected insofar as the distribution of oil rents functions as a powerful instrument of social control. Recall that in the early days of the 2011 Arab uprisings, fearing contagion, the Algerian regime, as well as each of the GCC states increased allocations from their burgeoning revenues to their citizens (in the hopes that this would keep them happy and off the streets).

But much depends on whether oil prices continue to fall and how long this period of low oil prices lasts. Given these uncertainties, it would be foolhardy to predict revolution in the Gulf monarchies, to say nothing of an imminent end to the Saudi aggression in Yemen.

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