Black gold…Yesterday, Today and Tomorrow

Introduction

The price of oil is of critical importance to today's world economy, given that oil is the largest internationally traded good, both in volume and value terms, creating what some analysts have called a hydrocarbon economy. In addition, the prices of energy-intensive goods and services are linked to energy prices, of which oil makes up the single most important share. Finally, the price of oil is linked to some extent to the price of other fuels. Therefore, abrupt changes in the price of oil have wide-ranging ramifications for both oil-producing and oil-consuming countries. The sharp decline in world oil prices since late 1997 certainly qualify as an abrupt and significant change.

Oil Price History and Analysis - Post World War II

Oil prices behave much as any other commodity with wide price swings ill times of shortage or oversupply. The domestic industry's price has been regulated though the production or price controls throughout the twentieth century.

Pre Embargo Period

Crude oil prices ranged between $2.50 and $3.00 from 1948 through the end of the 1960's. Throughout the post war period, exporting countries found an increasing demand for their crude oil and a 40ul(, decline in the purchasing power of a barrel of crude. In March 1971, the balance of power shifted. This happened as a result of the Texas Railroad Commission setting a proration at 100%, for the first time. This meant that Texas producers were no longer limited in the amount of oil that they could produce. More importantly, it meant that the power to control crude oil prices shifted from the US (Texas, Oklahoma, Louisiana) to OPEC.

A sharp decline in oil prices benefits oil importing nations and hurts oil exporters. For importers, lower oil prices act similarly as a tax cut, increasing consumer disposable income. This allows for looser monetary policy, and hence lower interest rates with lower inflation and stronger economic growth (as in the case of the US). Sharper oil prices, on the other hand, have been identified as a major cause in seven out of eight post WW II recessions in the US.

Firstly, oil revenues earned by producers are to a large extent "recycled" back to consumers in imports of all types of goods and services. In this way, oil-importing nations earn back much of the petrodollars they originally spend on oil purchases. A drop in oil revenues for oil exporters, as in the present situation, leaves oil producers with fewer petrodollars to "recycle".

OPEC (Organization of Petroleum Exporting Countries) was founded in 1960 with five founding members: Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. By the end of 1971 six other nations had joined the group: Qatar, Indonesia, Libya, UAE, Algeria, and Nigeria. These nations had experienced a decline in the real value of their product since foundation of the OPEC.

Impact on Major Oil Producers

Iran

Oil exports account for about 36% of Iran's state revenues, and 80-85% of total export earnings. It is estimated that repayment of Iran’s debt will be made much more difficult due to the sharp decline in Iran's oil revenues. Iran also will most likely experience a larger budget deficit, a depreciation of the Iranian riyal, and a shortage of foreign currency. Other problems facing Iran's economy include inflation and unemployment. At current oil export levels, Iran loses about $1 billion per year in oil export revenues for every $1 drop in oil prices.

Kuwait

Oil revenue accounts for about 90% of Kuwait's government income, which comprises nearly half the country's GDP.

Qatar

Oil accounts for about 70% of Qatar’s government revenues, and also has an impact on production of condensate and associated natural gas. Qatar has third largest gas reserves in the world, after Russia and Iran. Despite the fall in oil prices, Qatar is still planning to increase oil production capacity to mitigate declining revenues.

Saudi Arabia

Saudi Arabia is the largest OPEC producer and is a leader in the organization's quota decisions. It is a critically important player behind the recent oil price collapse. Saudi Arabia's difficulties are being compounded by the economic crisis in Asia, since Asia accounts for around 60% of Saudi oil sales.

On the positive side, lower oil prices to some point can be helpful for several reasons. Firstly, it has at least 250 billion barrels of oil in the ground and is among the world's lowest-cost oil producers. Considering the country's high reserve to production ratio of 100 years or more, low oil pi-ices can help accomplish several economic objectives like: deterring development of alternative energy sources, maintaining Saudi market share against its main competitors both in and out of OPEC, and deterring marginal non-OPEC oil production investment.

On the negative side, Saudi Arabia remains heavily dependent on oil revenues, for 88%of total export earnings, about 75% of state revenues, and 40% of GDP. The dramatic reduction in revenues will result in a significantly lower GDP growth rate, as well as higher budget deficit.

UAE

UAE's economy is slowing significantly, at least in part due to the decline in oil prices. This country has not been hit as hard as the other Gulf states because a significant portion of its revenue comes from business and trade. In response to falling oil export revenues, UAE has called for restraint in government expenditures.

Russia

Russian oil export revenues fell by about 25%, despite higher export volumes. This has contributed to a severe deterioration in Russia's trade balance. Meanwhile, the Russian ruble is sliding again, trading at 70.5 rubles per dollar, the lowest in four months and near last year's record lows.

Future of Oil Prices

Russia is planning for oil prices to drop to $30 per barrel in 2016. The country's top finance official, Anton Siluanov, said the government must be prepared for prices to fall further in 2016 as the global glut grows and new supply -- for example from Iran -- enters the market. That would spell more pain for Russia. Oil and gas exports make up almost half of government revenue.

Oil futures were trading at their lowest level in nearly seven years on Monday, sliding below $35 per barrel Dec 28, 2015. Russia is planning for oil to trade between $40 and $60 per barrel over the next seven years.

Saudi Arabia—Drastic slide in global crude prices is expected to force Saudi Arabia, the world’s leading oil exporter, to slash spending and cut back on the billions of dollars it spends on generous benefits for its citizens in next year’s budget. The 2016 budget unveiled points towards the first major opportunity for the government to publicly outline a strategy to cope with a prolonged period of cheap oil and soothe the nerves of both the public and investors in the Middle East’s largest economy. With the energy subsidies cut, the government is unlikely to immediately target consumers, who have become accustomed to some of the lowest gas prices in the world. Any reduction would risk a backlash from the public.

In an October 2015 report, the International Monetary Fund warned that, without reforms, the kingdom could run out of financial assets needed to support current spending within five years. It forecast this year’s budget deficit to grow to more than 20% of gross domestic product. The kingdom’s planned expenditure for 2015 was a record $229.3 billion.

In response to the collapse in oil prices, the government has already delayed a number of public projects and issued bonds for the first time since 2007. The government recently introduced a tax on undeveloped land in urban areas that is likely to be implemented next year. Other taxes, including a value-added tax, are expected as part of the economic reform plan.

Lower oil prices have impacted economic growth in the Gulf Cooperation Council countries. The GCC economies are set to grow by around 3.4 per cent this year and 3.7 per cent in 2016 – lower than previous years. “While these rates are considered high compared to other emerging markets, they remain below the region’s average growth rate of 5.8 per cent between 2000 and 2011,” the report said.

The six GCC countries currently hold 30 per cent of the world’s proven oil reserves with Saudi Arabia accounting for 15.7 per cent, Kuwait for 6 per cent and the UAE for 5.8 per cent. Together, they produced 28.6 million barrels per day of oil in 2014, equivalent to 32.3 per cent of total global production.

Oil prices have fallen from around $114 per barrel in June 2014, to around $50 in this year, dampening GCC government revenues. However, the report also clarified that not all markets have reacted in the same way. The decline in oil prices affected Oman and Bahrain the most, whereas Saudi Arabia, UAE, Kuwait and Qatar fared better.

“The more resilient economies benefit from strong macroeconomic fundamentals, such as more diversification, solid financial buffers and greater integration with world trade. The developed manufacturing and service industries in these markets allow less dependence on oil revenues,” the report noted.

The UAE has aggressively diversified its economy, with hydrocarbon revenues accounting for only 25 per cent of gross domestic product and 20 per cent of total export revenues. The country’s economy grew 4.6 per cent in 2014 and is forecast to grow 4 per cent in 2015 and 3.8 per cent in 2016, the report said.

Saudi Arabia, which depends on the oil sector for 80 per cent of its export revenues and around 85 per cent of its budget revenues, is also speeding up its diversification process. The kingdom posted a GDP growth rate of 3.5 per cent in 2014, with the economy slated to rise by 2.5 per cent and 3 per cent in 2015 and 2016 respectively.

“As oil continues to be a major contributor to economic performance in the GCC, economic diversification is a vital for Gulf countries to ensure continued healthy growth,” said Coface’s MENA region economist Seltem Iyigun.

“This has been showcased in Saudi Arabia and the UAE, which are driving sustained GDP growth through significant government investment in non-oil sectors.

Lower oil revenues and impact on budgets:

Low oil prices trouble Gulf States' revenues, budgets. Oil producing Gulf countries need higher prices to meet their 2015 budgets.

• Saudi Arabia- According to data provided by Energy Aspects, 87 percent of Saudi Arabia's budget is funded by revenues generated from oil sales, as the Kingdom needs oil prices to average $89.2 per barrel to balance its $229 billion budget for 2015.

• UAE need prices to reach $74 a barrel to balance its $76 billion budget for 2015, of which 76 percent is funded by income from oil. Also Kuwait needs oil prices to increase to $72.5 per barrel to meet its $61 billion budget this year, of which 79 percent is funded by oil sales.

• Iraq's 2015 budget is $104 billion, 96 percent of which is funded by oil, and the country needs oil prices to reach $99.6 per barrel.

• Iran, which is planning to raise its oil exports in the post-sanctions era, needs oil prices to reach $117.8 a barrel to meet its $94 billion budget for 2015, as 55 percent of it is funded by oil.

Some Gulf countries have found the solution through increasing their oil production and in lowering their official sales prices for their buyers in Asia and the U.S., in order to resist the price slump and preserve their share in the global oil market.

Between June 2014 and August 2015, Saudi Arabia has increased its oil production from 9.7 million barrels per day (mbpd) to 10.3 mbpd, while Iraq has raised its oil output from 3.1 mbpd to 4 mbpd, according to OPEC's monthly report.

In addition, the U.S. oil production jumped tremendously in the last six years, raising from 5 mbpd in 2008 to 9.6 mbpd in April 2015, according to the U.S.' Energy Information Administration, adding much to the glut of oil supply in the global market.

While oversupply is one of the major reasons behind the falling oil prices, low demand is another significant factor. In particular, the slowdown in Chinese and Asian economies and the prolonged economic recovery in Europe are creating expectations in the oil market that global demand is to remain low until the second half of 2016.

OPEC remains unresponsive

Despite the price slump, core-members of OPEC -- Saudi Arabia, the UAE and Kuwait -- are firm in their decision not to cut the cartel's output to raise prices.

The kingdom's oil minister, Ali al-Naimi said on Dec. 24, 2014 that his country would not cut production even if oil prices were to fall to $20 per barrel, claiming that the glut of oil supply in the world's markets and low prices are caused by non-OPEC producers.

"The OPEC decision to trim output is part of a broader two-year strategy – we are only nine months in. Essentially, prices need to stay lower for longer so that the low cost producers, mainly in OPEC member countries and in the Middle East, can influence the market in such a way that high-cost production is eased out first. We are seeing this happen at present hence lower oil prices are here to stay.