Drop in Oil Prices: Blessing for Some, Curse for Others

Novinite Insider » OPINIONS | Author: Branimir Kondov |December 24, 2014, Wednesday // 16:40| Views: | Comments: 0
Bulgaria: Drop in Oil Prices: Blessing for Some, Curse for Others

Novinite's team is publishing brief daily comments about how 2014 unfolded in Bulgaria and elsewhere.

Bulgaria’s struggling economy seems set to benefit from the recent slump in the oil price.

While the government’s revenue from Value Added Tax levied on petrol and diesel will drop, motorists and transport companies would welcome lower prices at the pump as decreased spending on fuels would increase the income they could spend on consumption and investment. Fuel accounts for about half of Bulgarian transport companies’ expenditure on domestic destinations.

Lower oil prices would also decrease Bulgaria’s spending on oil imports, thus reducing the country’s trade deficit and improving its current account balance.

On the dark side, however, is the delay in hydrocarbon drilling at Bulgaria’s Khan Asparuh Black Sea block by a consortium comprising France’s Total, Austria’s OMV and Spain’s Repsol.

Bad News for Russia, Iran

The steep fall in the price of oil may be great news for motorists and almost every business in the US, but it’s bad news for leading oil exporting nations such as Russia and Iran.

Earlier this month, US crude oil price fell to USD 58.50 a barrel in New York for the first time since July 2009 as the International Energy Agency cut its forecasts for global oil demand growth in 2015 and the Organisation of Petroleum Exporting Countries (OPEC) forecast a glut of oil next year after failing recently to organize a production cutback.

The crude oil price has fallen nearly 45% since the beginning of 2014.

Russia, which relies on oil and gas exports for up to a third of its budget revenue, needs oil prices of about USD 100 a barrel to sustain economic growth and social programmes amidst Western economic sanctions imposed over the crisis in Ukraine.

Falling oil prices have already cut revenue from oil sales, depressing the rouble, which has lost nearly half of its value to the dollar since January, fuelling inflation and restraining economic growth. According to analysts at Oxford Economics, if oil drops to USD 40 a barrel, Russia would see its economy shrink by 2.5% on average annually over 2015 and 2016.

Iran, which has learned to live with Western sanctions, is also set to suffer from lower oil prices. To break even, Iran needs to export oil at prices of USD 135-140. According to some Western analysts, with oil prices less than half of that, Iran’s leadership may find itself squeezed to make concessions in talks on its nuclear programme.

US, Europe, China to Benefit

The US, Europe and Asian economic giants like China and India all stand to benefit from the price plunge, with cheap oil possibly invigorating Europe’s sluggish economic growth.

For the US economy, the oil price decline is a like a tax cut, freeing up cash that can be saved or invested elsewhere,  US Treasury Secretary Jack Lew said in December.

For China, which is poor in oil and gas reserves, lower oil prices mean considerably lower spending on energy imports and an opportunity to counter the slowdown in its economic growth.

Analysts at Oxford Economics forecast that if oil falls to USD 40 next year, China will see economic growth rate of 7.1%. India, which imports 75% of the oil it consumes, will be another cheap oil beneficiary, with economic growth rate of 6.7%.

Saudi Arabia Driving Price Fall

The drop in prices to a five-year low in December has been driven by rising oil output in Saudi Arabia, the world’s leading oil exporter and the dominant power in OPEC. While increased demand for energy resources in North America can be seen as a motive, it is only part of the picture. Speculation has been rife that by ramping up production Saudi Arabia is willing to increase pressure on Iran to compromise on its nuclear programme.

The head of OPEC, however, has dismissed claims the cartel’s November decision to leave oil production levels unchanged despite the price plunge was designed to undermine oil exporters like Russia and Iran.

"Some people say this decision was directed at the United States and shale oil. All of this is incorrect. Some also say it was directed at Iran. And Russia. This also is incorrect," Abdallah Salem el-Badri, OPEC Secretary General said in Dubai on December 12.

Shale Oil vs Conventional Production

Waning of threats of disruption of oil supplies from Russia and the Middle East, economic slowdown in Europe and Asia and, above all, a jump in production from shale deposits and tar sands in the US and Canada have all contributed to the steep fall in oil prices.

According to Philip Verleger, former director of the Office of Energy Policy in the US Treasury Department, OPEC’s strategy “is to let prices fall and squeeze out the higher-cost producers,” Verleger said. “It’s a battle for market share.”
OPEC’s strategy may be to let prices fall to a point North American shale and tar sands production cease to be economically viable but this is a dangerous game as ”the shale producers keep lowering their costs of production thanks to technology.”

"Moving into 2015, we see downside risks to energy prices on the back of OPEC's decision to allow the market to stabilize itself. This could result in lower oil prices but also higher price volatility," Bank of America Merrill Lynch said in its commodities outlook released in December.

The bank cut its 2015 benchmark Brent crude oil forecast to an average of USD 77 per barrel and West Texas Intermediate (WTI) forecast to USD 72 per barrel in the document.

According to data compiled by Bloomberg, USD 80 per barrel is the average selling price at which shale oil producers in the US could operate normally. A lot of them, however, could operate with prices as low as USD 50 per barrel. Currently, production costs for shale oil vary between USD 65 and USD 90 per barrel.

Wrestling for Market Share

According to former US Energy Secretary Bill Richardson, the US should lift the ban on exporting oil and natural gas to bolster national security and create jobs.

"OPEC is diminished as a cartel but not out of the picture," Richardson said in an interview with CNBC on December 12. He added the U.S. should "reach out to the European Union to be the main suppliers of natural gas to Europe instead of the Russians."

The decision by OPEC not to cut production can also be attributed to fears that any reduction in oil supply will mean giving away market space to new suppliers in the US and Canada. The expectation of an increase in supply is based on the discovery of shale gas in the world. The shale gas revolution in the US, the development of Canada’s tar sands and Mexico’s decision to develop the country’s energy resources have changed the oil market’s expectations.


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