Wednesday, January 14, 2015

The Good, Bad, and Ugly of Plunging Oil Prices, Foreign Policy

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The Good, Bad, and Ugly of Plunging Oil Prices

The Good, Bad, and Ugly of Plunging Oil Prices
Crude oil prices plunged to a six-year low Tuesday in a potentially painful threat to oil-exporting nations that rely on crude to power their economies. The drop brings some welcome relief to countries that have been struggling with economic headwinds, but brings a mixed bag for others, like the United States, that are both big producers and consumers of oil.
Oil prices are still looking for a floor, in part because the persistent mismatch between global supply and demand continues even as big oil producers inside OPEC keep spooking the market by refusing to countenance any voluntary production cut. The energy minister for the United Arab Emirates on Tuesday, Jan. 13, dismissed the idea that OPEC would cut production to boost prices and said it was up to other oil suppliers, such as the United States, to blink first.
“Those who are producing the most expensive oil — the rationale and the rules of the market say that they should be the first to pull or reduce their production,” the minister, Suhail Al Mazrouei, said. Brent crude prices in London fell 4 percent while he was speaking and hovered around $46.50 a barrel midday Tuesday. West Texas Intermediate prices in New York fell slightly to below $46 a barrel Tuesday.
The speed and the scope of the fall in oil prices is stunning. The new year is not even two weeks old, and benchmark crude prices have already plummeted more than 15 percent. Look back further and the drop is even more eye-opening: Prices are down more than 60 percent since last summer. A top Saudi official, Prince Alwaleed bin Talal, said late last week that the days of $100-a-barrel oil are gone forever. Many analysts believe that oil prices between $30 and $40 per barrel are a real possibility. That level was last seen during the darkest days of the 2008 global financial crisis; now oil traders are placing bets on oil sinking as low as $20 a barrel.
The oil-price plunge is becoming less a risk than a painful reality for countries that live and die by selling black gold. Ratings agency Moody’s justdowngraded Venezuelan debt to the second-lowest rating. Moody’s says there is little that the Venezuelan government can do to halt the economicrot, short of praying for a rebound in oil prices. Venezuelan President Nicol├ís Maduro has toured the world, hat in hand, asking fellow petrostates to cut production to boost oil prices, but with no luck so far. The only bright spot: Moody’s upped Venezuela’s outlook from negative to stable, but only because the country has already hit rock bottom.
Russia’s economic woes are getting worse too, with the ruble hitting one-month lows on Tuesday. Russian bond yields are at Venezuelan levels, and ratings agencies have also downgraded Russian debt. Default risk is soaring, making Russian debt some of the riskiest in the world. All that will translate into economic contraction this year, creating the very real risk that Russian President Vladimir Putin again looks for foreign adventures as a distraction.
Falling oil prices aren’t just hurting economically dysfunctional states. They are also buffeting Britain’s North Sea oil sector, with big energy firms there reining in spending and shedding jobs. And the U.S. shale gale, which proved resilient to sliding prices late last year, is finally showing signs of the strain, with oil producers pulling drilling rigs out of fields in Texas and North Dakota.
Cheaper energy does create some winners though. Asian economies, in particular, stand to benefit. Ian Bremmer, head of risk consultancy Eurasia Group, says cheap oil will benefit China most of all, by giving President Xi Jinping the space to rejigger the world’s second-largest economy away from inefficient, state-owned businesses and more toward consumer spending.
Like China, countries such as Japan and South Korea benefit in more ways than one from falling oil prices: The falling prices also make imported natural gas cheaper, because most natural gas contracts are still linked to the price of oil. Asian countries paid about $20 per million British thermal units for liquefied natural gas (LNG) imports in March 2014. By December, LNG prices had plunged to about $12. That’s a huge and unexpected stimulus for the world’s biggest LNG importers. It’s especially good news for Japan, whose energy appetite after the nuclear shutdown in the wake of the 2011 Fukushima meltdown drove it to trade deficits for the first time in decades.
Globally, though, cheaper oil doesn’t look set to translate into stronger growth as it did in the past. The World Bank, in its latest outlook, trimmed the global growth forecast from 3.4 percent growth to 3 percent growth, despite expectations of further declines in the price of crude. That’s in part because many consumers around the world are still cautious and are recycling extra cash into savings rather than consumption, while big oil-producing economies are reeling.
But the big question remains: Is cheap oil a blessing or a bane for the United States, which has ridden an unexpected oil and gas production boom in the last few years to become one of the world’s premier producers?
Historically, for the world’s biggest oil consumer, cheaper crude is nothing but good news: Consumers who spend less money at the gas pump have more cash with which to buy other things. Nationwide gasoline prices have now fallen for 110 straight days in the United States and have fallen from $3.31 a gallon a year ago to an average of $2.12 a gallon today.
Walmart, the world’s biggest retailer, just posted its first quarterly salesincrease since 2012 thanks in part to cheaper gasoline, which frees up more cash for the chain’s poorest customers. Economists estimated late last year that cheaper oil prices amounted to a cash stimulus of about $1,800 per U.S. household; that effect is likely larger now that oil prices have fallen further. And revised third-quarter GDP numbers show a healthy rebound in consumer spending underpinning some of the most robust growth of the last decade.
But these days, the United States is an oil-and-gas giant; states such as North Dakota, Alaska, Oklahoma, and even Texas are heavily reliant on a healthy oil patch for economic growth and job creation. That newfound reliance creates a fresh vulnerability and could cancel out many of the broader benefits of cheaper energy, at least in certain parts of the country. It’s not just the direct impact to energy companies, which are a small part of the economy even in states like Texas. Rather, energy jobs and investment filterthrough the rest of the economy and give a particular boost to services, from hotels and restaurants to health care.
As long as crude oil prices stayed relatively high, as they were through much of last year, U.S. oil producers could weather the downturn. But oil prices in the $40-per-barrel range are starting to seriously test the economics of many operations. That’s because unlike other new sources of oil production — such as Canada’s tar sands — U.S. tight-oil production relies on continuous drilling of wells to maintain output levels.
Oil field services company Baker Hughes reported Friday that the rig count — the tally of oil and gas wells in the field — fell last week by the most since 2009. Rig counts have fallen for five straight weeks, an indicator that oil producers that live on the edge are hedging their bets. In North Dakota’s massive Bakken formation, cheap oil prices are making most playsmarginally economic now.
If oil prices stay low, investment bank Goldman Sachs said, U.S. output willdecline in the second half of the year. On Tuesday, the U.S. Energy Information Administration forecast that falling prices could indeed dentU.S. oil production this year, but just a bit.
Ultimately, the big risk to the U.S. economy lies in just how that yin and yang play out. If cheaper oil helps consumers more than it hurts energy producers, the drop would essentially extend the Federal Reserve’s now-defunct policy of priming the economy with easy money. And while that could extend economic growth for another few quarters, it also sets the stage for a harder landing sometime next year — just in time for the 2016 presidential election.
Photo by MARWAN NAAMANI/AFP/Getty Images
Note: This post was updated shortly after publication to include the World Bank’s outlook.

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