Oil

Standard

In the past twenty years the price of oil has swung dramatically from a low in the $10 a barrel range in the late nineties to highs approaching $150 a few years ago. Currently it sits at roughly $50 a barrel though some speculate it could drop as low as $35 before making a recovery. What does it mean?

Both a lot and a little at the same time. Oil is a fungible commodity — that is, one barrel looks exactly like another and the cost of moving it from place to place is a small part of the total value of the product. Fungible commodities are most susceptible to wobbles in supply and demand. Currently the demand for oil is at its lowest in several years — caused by slower rates of growth in the BRIC nations — while supply is at an all time high. Downward price pressure is high.

Add to that the geopolitical factors. The Saudis and other OPEC countries need to retain a significant share of the market if they are to continue to have stable governments at home and significant influence abroad. Large increases in North American production as well as Russian exports to Europe have dramatically cut Saudi influence and they are now turning on the taps with a view, at the very least, of making American shale oil production uneconomical in the medium term, but, possibly also with a view to crippling the Russian economy.

Americans have not re-acted as a government because it is almost impossible for a market economy to respond to non-market forces such as the long-term irrationality of the Saudis depleting their own reserves by selling at bargain basement prices. There will be a reaction — uneconomic wells will be capped and drilling programs curtailed — but those are responses to price not politics.

Yet, oddly enough, the world, which should be leaping for joy at the sudden fall in a key input commodity, seems to be staggering under the weight of their new found opportunities. Stock markets have been in turmoil and predictions of the effect of lower oil prices by economists have hardly been consistent.

In part, this is because so many countries around the world now depend on oil income to sustain their governments and economies. A fall in oil prices damages about 20 to 30 national economies to a greater and lesser extent (including Canada). Many of those — unlike Canada — have no secondary benefits, like reduced manufacturing costs, to compensate for the loss. Thirty sick national economies are obviously going to hurt the global economy.

But I suspect there is something else at play. We know, for example, the stock markets seldom reflect the economic health of a nation. This is even more so in the era of high frequency traders and complicated financial derivatives where brokers make money precisely from a downturn in the economic fortunes of others.

My own view is that the current oil crisis will prove less significant than those of the recent past, in part because oil itself is less significant. High oil prices didn’t simply drive the fracking industry; it provided market incentives to technologies that replace oil as a provider of economic energy.

But that’s ten minutes.

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