Introduction
As indicated last week, in order to promote an intelligent appraisal of PetroCaribe and the current regime of Guyana’s oil importation, an appreciation of the trajectory of the current global crude oil price is essential. Indeed, the recent downward trajectory is perhaps the main reason for the recent barrage of international and regional criticism directed at the Venezuelan PetroCaribe initiative, which started back in 2005. Regional companies and agencies feel emboldened to ask governments, because of cheap oil today, if PetroCaribe is a lifeline offered by Venezuela to the region or a noose!
As part of this appraisal I introduced last week ten key determinants (factors) driving the current downward trajectory in the global crude oil price. Of the ten I was able to offer a brief comment on the first two. Today’s column will offer brief comments on the remaining eight.
OPEC as marginal supplier
The twelve member Organisation of Petroleum Exporting Countries (OPEC) was established in 1960 as a producers’ oligopoly. Its classic aim has been to keep oil prices as high as the market could bear without this leading to significant reductions in the demand for oil. Traditionally, this has meant that OPEC has operated as the global marginal supplier seeking to keep prices up by adjusting its supply to balance shifts in global demand. However, oil production costs, wealth and income levels vary greatly among OPEC members so that the burden of being the global marginal supplier has been uneven. Saudi Arabia is dominant in the grouping, which produces about 40 per cent of global crude oil supply. Saudi Arabia’s cost of production is perhaps the lowest and has been variously estimated at single digit US dollars per barrel.
Perhaps the crucial observation is that at its November 2014 meeting, OPEC decided not to act as the marginal supplier. It decided not to cut crude oil supplies to the global market forcing oil prices to fall as global oversupply (if not glut) prevails. The costs of this decision to OPEC members is extremely uneven and it is believed this is being done in extremis in order to protect OPEC’s market share by driving out high cost crude oil producers, especially the shale oil producers in the United States.
Geo-strategic concerns
Energy security is at the heart of the survival of modern developed states. Some analysts argue therefore that geopolitics trumps market behaviour if the two are found to be in opposition. From this perspective the trajectory of falling crude oil prices principally reflects the balance of geo-strategic forces and not simply market forces of demand, supply, and expectations. These theorists raise serious conspiratorial conjectures, for example that the US and Saudi Arabia are conspiring together to squeeze Iran, Venezuela and above all Russia. The essence of such a view is that even if the US harms its rising fracking industry and Saudi Arabia loses income now, both benefit immeasurably from the setbacks their actions cause to their strategic adversaries.
An important feature of the global oil market, which is not widely realized, is that the bulk of crude oil supply comes from state-owned businesses. This makes the industry susceptible to government policy direction, guidance, and legislation, which in turn will influence the trajectory of oil prices.
Elasticity
The responsiveness (or elasticity) of crude oil demand and supply to its market price is critical to the current trajectory of falling prices. If the global supply of crude oil was driven predominantly by competitive independent businesses I would advise readers of the classic truism, which is the cure for low oil prices is the continuation of low oil prices! If prices remain low the demand for oil will grow putting pressure on prices to rise. At the same time low prices will drive out those producers that are not cost competitive. As a result both rising demand and reduced supply would put upward pressure on prices.
This however will not happen for at least two reasons: 1) non-commercial considerations affecting both the demand and supply of crude oil, and 2) the lumpiness of oil production which makes long-term responses more doable than short term ones.
Speculation
With, as we have seen, a highly complex set of economic and geopolitical factors at work, the crude oil market is a major segment of the world’s speculative industry. There are specialist oil traders who set prices by buying and selling oil futures contracts; hedgers who trade in the futures market in order to secure an agreed supply on a fixed date at an agreed price; and speculators who seek to make a profit from futures trading. As a result every potential or actual effect on crude oil supply is immediately/instantaneously priced. Moreover the price of crude oil is normally quoted in US dollars so that it is tightly interwoven into the foreign exchange market as well. When speculation is orderly and stabilizing it supports the efficiency of the oil market; when it is destabilizing it compounds adverse consequences.
Contagion effects
Experience has shown that dramatic changes in oil prices will produce contagion effects in financial and equity markets. In the present circumstance of a rapid fall in crude oil prices one thing is certain, substantial income transfers are taking place from oil exporting countries and regions to net oil importers. Countries experiencing income losses are therefore faced with turbulence in their financial and equity markets and the extent of this depends on the severity of the income losses and the dynamism of the non-oil producing sectors.
Global economic growth
One of the best established correlations in economics is that between economic performance and energy use. Some analysts argue that sluggish global growth (along with global oil oversupply) is a major determinant of the current trajectory of low oil prices and until full robust broad based growth is achieved oil prices will remain low.
Alternative energy sources
It is evident that alternative energy supplies (substitutes) would affect the price of oil. This however is more a long-term likelihood than a short or medium-term probability
Technology and oil resources
Technology is constantly reducing the lead times between oil exploration, discovery, and production. It is also constantly raising energy efficiency.
The relentless search for alternative sources of energy supply will continue and all these will certainly affect the long-term price of oil. My concern however is with the trajectory of low oil prices for the rest of this year and into 2016 and its impact on PetroCaribe and Guyana’s regime of oil importation.
