Precarious to predict how petroleum price fall will play out

Brent crude hit an 11-year low of $36.20 this week, in part because Opec has ceased to function.

Precarious to predict how petroleum price fall will play out

So, ding dong, the cartel is dead. By all means sing and ring the bells out. Just not too loudly.

This isn’t, of course, the first time oil prices have suddenly taken a tumble.

Nor would the Organisation of Petroleum Exporting Countries be the first oil cartel to go limp.

So we, or at least energy guru and Pulitzer prize-winning author Daniel Yergin, know something about what to expect.

In the short term, the answer is straightforward: Cheap oil is good for growth in consumer economies and bad for producers.

However, there would be reason to think hard about how the sudden wealth transfers that extreme oil-price volatility causes will pan out over time.

Opec has rarely been a well-meaning price regulator and was often ineffective; today it controls only about a third of oil output.

For oil-consuming countries, low crude prices act as a free tax cut, but they also drive down investment in future output.

Capital expenditure in oil-gas extraction tends to track the price of oil pretty closely: When demand bounces back or there’s a supply shock, glut can turn abruptly to shortage and prices can rocket upwards, triggering recession.

Think 1973. In that year, Opec imposed an oil embargo in response to US involvement in the Yom Kippur war and the oil price quadrupled.

Annual US growth declined from 5.6% in 1973, to minus 0.5% in 1974. Says Mr Yergin: That was a dramatic example, when oil markets were tight, demand was strong, a crisis occurred and the oil price exploded.

Prices then fell back in the 1980s and remained low for years, changing expectations and investment appetite.

As late as 2003, institutional investors were urging oil firms to exercise what they called capital discipline. They were saying: “Don’t invest heavily, because oil will be at $20 forever.”

The next year, prices began their explosive rise. That was because people had been investing for a $20 world and then demand took off, led by China.

IHS, the consulting group of which Mr Yergin is vice- chairman, projects that oil companies around the world will invest $600bn (€548.6bn) less in developing new production between 2015 and 2020 than it had been forecasting in 2014.

This would be great for climate change policy if all the investment shifted to renewables, but it probably won’t, so prolonged low prices and investment in oil capacity runs similar risks today.

For producer countries, low prices tank the economy, slash budgets and can produce political instability.

An oil-price slump in the 1980s was one of many reasons why Saddam Hussein invaded Kuwait.

Saddam had ended his 1980-1988 war, with Iran owing about $37bn to Kuwait and the other Gulf States.

When the oil price fell from over $100 a barrel to settle below $40 by the mid-1980s, Iraq’s government was badly hit.

Venezuela’s economy was struck by the same oil-price slump.

The economy contracted sharply and then flatlined for a decade, inflicting economic pain on much of the population.

Former president Hugo Chavez is more often regarded as a beneficiary of the long oil-price rise that followed his election in 1999 — much like Russia’s Vladimir Putin, who came to power at the same time.

But according to Mr Yergin, it was another oil price collapse in 1998 that “set the stage” for Mr Chavez’s election.

So whom should we worry about today? One country is, again, Iraq.

Already politically fragile, the IMF warned this summer Iraq faces two existential threats: Islamic State and a falling oil price.

A Syrian-style implosion is only too easy to imagine.

Russia has coped relatively well by allowing the ruble to fall with the oil price, broadly maintaining public finances.

But if oil stays at $40 or below for a number of years, that may not be enough. It is hard to predict how Mr Putin would respond to economic meltdown.

Nigeria, a country of almost 180m people that’s also battling a terrorist insurgency, Boko Haram, is getting hit especially hard; energy accounts for 35% of GDP and 90% of exports.

Earlier this week, President Muhammadu Buhari asked parliament to adopt a budget 20% larger than last year’s to stimulate the economy, paid for by new borrowing.

Even if that’s smart policy, it’s a sign of desperation.

Opec may well be on its way out. It is the third global oil cartel that has sought to control the commodity’s supply and thereby its price.

The Texas Railroad Commission regulated output at a time when the US dominated oil production; the “Seven Sisters” oil companies also formed a cartel to carve up resources and control prices.

None is missed.

When it comes to low oil prices, though, we should be a little careful what we wish for.

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