Oil Prices Plummet.. Why And What Does It Mean?

I had mentioned previously that the decline in manufacturing in China has led to significant declines in oil consumption. This has led to a glut in the oil supply, leading to a reduction in oil prices.

Since beginning this article, Brent Crude oil prices have taken the steepest cut in history. Meaning since that benchmark was established in 1985.

A complex issue. Oil production and prices are a complex balance of cooperation and competition between oil producing countries. Too much oil produced leads to prices plummeting to the point where it becomes more expensive to produce than profits made. Too little oil production leads to shortage conditions and global inflation. The breaking point for each country is different between cost and profit.

OPEC. Historically, this balance has been roughly maintained by OPEC, though the balance has not been fair to all members. To be honest, complete fairness would be next to impossible, adding to the complexity. Primarily, OPEC has been dominated by Saudi Arabia and decisions made by OPEC customarily favor the Saudis.

OPEC+. There is also a coalition of non-OPEC nations, commonly referred to as OPEC+, which commonly follow the decisions made by OPEC. Those decisions generally include whether member nations will reduce or increase oil production for the purpose of regulating oil prices to oil consuming nations. Russia is a member of OPEC+.

The US does not coordinate. One major point to note here. While the US is now the world leading oil producer, the US is not a member of OPEC or OPEC+. The US attempts to regulate oil market prices and conditions via political, economic and military force, as opposed to any form of cooperation or coordination with other oil producing countries. That force includes sanctions against Iran, Russia and Venezuela. The US also seizes control of much of the oil produced in Syria and Iraq.

Petrodollar. Another key point to keep in mind is that the value of the dollar largely depends on the petrodollar system, a system which I have written repeatedly is on the decline as other nations adopt alternative currencies for oil trade, bypassing the dollar. While the petrodollar system has been instrumental in establishing a common currency for oil trading, that is largely a matter of convenience. Multiple countries have made overtures of establishing a common currency for international trade, independent of any sovereign currency. In any case, the less the dollar is used as a currency of trade for oil, the more unstable the dollar becomes in relation to other currencies.

Reduced demand. For well over a year prior to the Corona virus, China had reduced their purchase of US oil by as much as 75% as a result of the trade war between the two countries. The current Corona virus situation really only directly affects that remaining 25% but has the potential to eliminate that entire 25% should China choose an oil supply source other than the US, which is entirely possible.

Shipping and freight. One more impact of the disruption in the general supply chain is, downstream from manufacturing, freight and shipping have declined. This has been a global trend, not limited to China by any means. Shipping has been on the decline since long before the Corona virus arose. The Corona virus simply caused a sharp sudden drop in the shipping industry on top of the existing decline.

Current events. This brings us up to current events. Not long ago, Russia announced that they would not be reducing oil production as a result. In addition, Saudi Arabia announced that they will actually be increasing their oil production next month. Western media is reporting that this is in retaliation to Russia’s statement but that makes very little logical sense. Russia is far more capable of sustaining lower oil prices than either the US or Saudi Arabia, as they are more diversified, being the world leading exporter of grain and expanding agricultural output. Saudi Arabia and the US are far more susceptible to declines in oil prices.

Future events. As oil consumption remains declined, this has occurred during winter months in the northern hemisphere, where the majority of highly industrialized nations reside. As winter ends and milder weather takes over, oil consumption will decline further just as Saudi Arabia increases oil production and Russia maintains stable production. The end result will be an oil oversupply, causing the price of oil to decline further. Eventually US oil producers will be forced to curtail production, leading to mass layoffs in the oil industry, even as the disruption in the supply chain causes layoffs in other industries. Oil futures are already reflecting the fact that this is fairly common knowledge. This will result in oil industry stock prices declining, which are historically some of the most stable stocks on the market.

Eventual recovery? Of course, at some point the Corona crisis will end in China. Though by the time it does, it may well be in full swing in other countries. When China first comes out of their crisis, oil prices will be at the bottom of the market as compared to any prices since the 1990’s. Yet that may not be enough to bring the oil market back to stability.

Real motivation? Contrary to the claims of western media, there is good reason to question whether the motivation for this oil war is truly between Russia and Saudi Arabia. Until this time Russia has cooperated with production limits. It has been the US which has gone beyond all discussed limits, destabilizing the OPEC market. Cost of oil production for Russia is higher than SA but much lower than shale and tar sands oil production in the US. This oil war stands to gut the petrodollar system entirely.

This oil war is something both SA and Russian economies would survive with measurable but not crippling impact. The countries that will be most hurt at first will be smaller oil producing nations with no diversity to their core economy. However, if they can force the petrodollar system into submission and bring US domestic oil production to it’s knees, OPEC/OPEC+ nations could well see a long term gain and establish dominance over the oil market permanently.

It may not take that much. Estimates say that US oil production must maintain an average of $60 a barrel to be profitable (that may have come down slightly in recent years). That’s for established fields. To tap new fields, oil would have to reach and maintain $70 a barrel to be worth the effort.

On the up side, lower oil prices benefit the average consumer. Though that is entirely contingent on the price of other goods remaining stable, which is absolutely not guaranteed at this moment in time due to the supply chain disruption.

The real effects of this will be seen rather quickly over the next few weeks to months.

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