The Politics of Global Oil
Oil prices continued to plummet last week to below $60, and experts predict that it could continue to drop. All of a sudden, what seemed like a boost to the global economy has caused consternation and worry among economists, as the recognition that the oil supports jobs across a number of important sectors. There are of course rumors circulating about the politics of the situation and what is driving it.
One school of thought is that “OPEC is trying to drive out the competition”. That is, they are hoping to be able to drive out many of the directional driller outfits using fracking technology that has boosted output in the United States over the last two years. There is some truth to this. The drilllers that were early to the party were able to drill relatively shallow at a low cost, and had very good returns on these early fracking forays, that has created a real economic upswing. However, as these drillers are forced to drill deeper, their costs are going up – and if oil is at $57/bbl, the costs are unsustainble, and they will be forced to shut down operations. Bigger operations, such as the major projects in the Canadian oil sands, can continue to operate profitably at oil prices upward of $40/bbl, so will be relatively untouched by these developments. However, the smaller operations in the fracking industry will in all likelihood be packing up their things and going home, and so will be the jobs associated with these operations. In addition, the railroads which have been run at peak capacity due to the plethora of oil being shipped by rail will see a downturn. This is in truth probably a good thing, as there is not even enough capacity to operate the railroads to bring farmers’ crops to market, causing prices of wheat and corn to spike as railyards continue to push more and more oil carriers onto the tracks, causing massive bottlenecks in railyards and leaving crops undelivered during a bumper year of production.
On the other hand, there may be more to it than OPEC trying to drive out smaller players. Jason Schenker from Prestige Economics, spoke at our SCRC meeting, and pointed out that OPEC members really don’t see smaller drillers in North Dakota as a threat. Rather, their worry is more on the state of the global economy, and the fact that China and India’s GDP continues to drop. In such cases, it is likely that there will indeed be the beginnings of a global recession. In such cases, the theory goes, the economy needs a “jumpstart” to grow demand for vehicles and oil, which means growing overall demand for new vehicles, and hence demand for oil. Remember that revenue = price X demand, so if price goes down, than demand will jump…a supply side strategy. Schenker believes that OPEC is more worried about the global economic recovery, and by boosting oil inventories, prices will drop and bump up all global economies….and prices will naturally drop.
It will certainly be interesting to see which way this will go…