17.10.2014 Author: Viktor Mikhin

The World Market and Oil Prices

345345The price of oil continues to fall catastrophically in all world sites. For example, in mid-October Brent crude oil was already being traded at around 85 dollars per barrel. At the New York Stock Exchange the price of a barrel of WTI oil was 84.9 dollars. “Oil futures are heading to the 80 dollar mark, and it probably won’t stop there,” remarks Confluence Investment Management analyst Bill O’Grady. For the past two months the “black gold” has fallen in price in general by 20-25% and most experts are talking of the growth of a “bearish” trend on this market. It’s not suprising that the reasons for the fall in the price of “black gold” are being hotly debated around the world including Russia. A huge number of reasons and arguments are being put forward, which at the end of the day are intended, it would seem, to hide the true reasons for the problem that has arisen.

Among the main reasons for the fall in oil prices are quoted, above all, a certain agreement between the USA and Saudi Arabia against Russia and Iran and the large volumes of raw materials that are allegedly being sold illegally by the fighters of the “Islamic State” organisation. This was precisely the reason that was proposed by The Wall Street Journal, indicating that Washington and Riyadh have signed a secret pact, the contours of which are being sketched out with increasing clarity. The first sign of the thaw in the relations between these two countries, which were spoilt as a result of the support given by Washington to the Arabic revolutions and Muslim-brothers, is the fact that Saudi Arabia has officially joined the western coalition, which is carrying out military operations against “Islamic State” in Iraq and Syria. Other signs of the rapprochement are also exist, the American journal remarks, for example, the Saudis have succeeded in exerting pressure on the USA and reaching agreement on training the combatants fighting against Bashar Assad in Syria.

In response Riyadh started to reduce the price of its oil on a regular basis, which had become all but the most powerful weapon in the war being waged in the Middle East by the Sunnis and Shiites, along with their allies. Saudi Arabia has decided simply to knock down world prices and put economic and political pressure on Iran and Russia. By using this oil weapon, the Kingdom hopes to moderate Iran’s appetite for nuclear armament, and to force Russia to refuse widespread support for Bashar Assad.

Although all these difficulties have been known about for quite a long time, the plummeting of oil prices have started right now. Some politicians explain these dynamics by a “conspiracy theory”. One of the wealthiest American financiers George Soros proposed only this summer that the USA should punish Russia for its policies in the Ukraine by lowering the prices of oil. Saudi Arabia, one of the USA’s allies, would be able to play into the hands of its partner, as some experts assume.

At first glance this theory, which was one of the first to be put forward, sounds great but, however, is not one that might explain all the nuances of the current state of the oil market. The allegedly huge supplies of “black gold” at dumping prices by “Islamic State” fighters do not stand up to any criticism. It is a well-known fact that, in controlling, according to various sources of information, 240 square kilometres of oil fields on the territory inhabited by Kurds, they sell the raw material via Turkey to the world market at 25 dollars. It’s perfectly clear that these supplies are not as big as what people say, and they are not capable of having any significant impact on the world market. Besides, the first thing the American air force did was to bomb precisely these oil fields. As is well-known, Ankara is an active participant in the global anti-terrorist coalition, and should, in theory, close this channel. By the way, these are the grounds for the widespread activities of those international organisations whose duty is to track down and take actions against price dumping. True, Turkey, as we know, is a member of NATO and her unlawful activities do not attract the slightest attention of the international organisations currently falling under the close control the USA.

Serious analysts see completely different reasons for the fall in prices, and there are two of them. The first and the most important is the deceleration of the world market rates of growth in all areas and in all continents. For example, the International Monetary Fund (IMF) has decreased the forecast growth of the global economy this year from 3.4% to 3.3%, and the forecast for 2015 is reduced from 4% to 3.8%. The reason for the decrease is the actual recession in Brazil and, moreover, the economies of Russia and Germany are, in the view of IMF experts, tottering on the brink of recession. At the same time there is a gradual slowing down in the growth rate of the GNP of China, which had previously purchased almost all oil futures, wherever they were issued.

It’s perfectly clear that the predicted deceleration of the growth in demand has also had a part to play: the International Energy Agency (IEA) predicts – deterioration in the growth rates of China and Europe, and the growth in 2015 is also forecast to deteriorate. For example, in Europe the annual forecast for growth has been revised by the IEA from -0.4% in January to -0.1%. In China in January the growth rate of oil for the II and III quarters was predicted at 4% and 3.3% respectively, but was actually only 2.2% and 1.8%. For the IV quarter, the IEA predicts the growth in Chinese demand of a total of 2.9% against 4.6% expected at the beginning of the year.

The second reason is the active processing of shale oil deposits by the Americans, and the fact that this raw material almost completely meets their requirements. In these conditions the Saudis have lost a considerable American market and we are now facing a serious dilemma: either wind down oil production or reposition ourselves on new sales markets, increasing supplies to those countries where they had definite quotas. “Saudi Arabia is acting solely in her own interests, attempting in conditions of over-production of oil, a fall in the global economy and intensifying competition to “stake out claims” at least of old sales markets,” observes the Financial Times. According to this version, the main aim of the Saudis, dumping on the oil market, is to obtain, at least for the mid-term, a higher revenue from oil by means of persuading competitors to freeze new investments in offshore projects and, maybe, to stop the growth in offering raw material from the USA’s shale projects, the profitability of which, as estimated, is in the range of 70 dollars per barrel.

Saudi Arabia currently accounts for approximately a third of OPEC’s oil – that’s something like 9.7 mln barrels a day. The USA, which enjoyed the highest level of extraction in 1986, has a comparable figure. The Saudis, along with the other OPEC countries, can undoubtedly reduce the amount of extraction of “black gold”, in order to stop the prices plummeting, but already at the beginning of October the Saudi Arabian state oil company reduced the price for customers in Asia by 1.2 dollars, to 90.02 dollars per barrel – and that, as they say, is not the end of it. In order to keep the market share, the Saudis have also offered a lower price for its November contracts and to Europeans, who have demanded in return to undertake to purchase the entire contracted volume in 2015, reports The Wall Street Journal.

Representatives of Saudi Arabia declare in private conversations that they have no objection to the drop in prices to $580 if it helps the country to fight competitors, including the USA, where the extraction of shale oil is increasing rapidly. The Minister for the oil industry of Kuwait Ali al-Omair told the state information agency KUNA that OPEC is hardly going to cease the extraction of oil because, in the organisation’s opinion, the prices will fall anyway regardless of this. In the words of the Minister, the prices may stop at the $76-77 per barrel mark, because this is the prime cost of extraction in the USA and Russia. A meeting of OPEC will be held on the 27 November, and some of the participants are proposing to reduce extraction from the current 30 million barrels a day, to enable the world prices to return to the $100 per barrel mark. In the meantime, Saudi Arabia, OPEC’s largest producer, increased extraction in September to 9.7 million barrels a day from 9.6 million in August.

But the reduction in oil prices, quite naturally, also impacts on the United States, where the extraction of shale oil is being actively developed, and in which a fair amount of money has been invested. And, moreover, the extraction itself is a lot more expensive than in Saudi Arabia. The reduction in the prices by a further 4-5 dollars will force American producers to sharply reduce their budgets, observes The Wall Street Journal, citing Paul Sankey, Wolfe Research analyst. In addition, extraction is currently being relocated to areas that are difficult to access and the price is increasing all the more. Specialists believe that, if the oil prices fall lower than a certain level (around $85), extraction will produce low return, investments will not pay off and an oil deficit will ensue.

The tendency to reduce the prices has already affected a lot of oil producing countries – this has been confirmed by a number of countries such as Iraq, Iran, Venezuela and Bahrain. According to Reuters, the government of Qatar reduced the official price of the September consignment of Marine oil back-dated by $6.75, in comparison with the August prices, and of Qatar Land by $6.25. Experts in one voice explain Qatar’s reduction in prices by the attempt to compete for the Asian market.

Hence, whatever the reasons for the fall in prices, it is blatantly clear that the oil producing states have already started repositioning of the global oil market, launching a “cold war” of their own between themselves. If only it doesn’t develop into a “hot” war, which at the present moment can be predicted and expected. At any rate, the changes in these countries will be major, not just economical.

Viktor Mikhin, a corresponding member of the Russian Academy of Natural Sciences, exclusively for the online magazine “New Eastern Outlook”.