The dramatic crash in the price of oil is rewiring the circuits of global capitalism by creating enormous volatility in the world's stock exchanges, hammering banks that made billions of dollars in loans to energy firms, and ravaging the budgets of the world's largest oil-producing countries. Today, oil is trading at around $30 a barrel – roughly 75 per cent below its price of $114 a barrel in the summer of 2014 – that is, a year and a half ago. The collapse has been as sharp as it has been sudden, confounding economic analysts, energy producers and global financial centers.
Daniel Yergin, one of the world's leading oil analysts and the author of The Prize: The Epic Quest for Oil, Money and Power, predicted in early November 2015 that oil prices were at or near the bottom of their fall – when oil was selling at $47 a barrel. Yergin, like other analysts, counted on two factors to put a floor under the price of oil. One, he assumed that Saudi Arabia and the rest of OPEC (the Organization of Petroleum Exporting Countries) would curtail production in order to keep prices from falling further, and two, he expected a sharper contraction in production among ‘higher-cost’ producers – such as Canada tar sands, U.S. shale oil and various offshore drilling operations – that would further limit supply.
Instead, Saudi Arabia has kept pumping, and though the low price of oil will likely wipe out more expensive fracking and tar sands operations in North America, it's not happening fast enough to bring supply in line with falling global demand – at least so far. By January 13, Yergin was reassuring investors that oil probably wouldn't go as low as $10 a barrel. Dramatic oversupply is what drove oil prices down to $10 a barrel in the late 1990s, when a sharp contraction in growth that swept through Asia's developing economies weakened demand.
Today's downward spiral in the price of oil is likewise being driven by fears of a slowdown in Asia – in particular, the cooling off of China's economy after three decades of double-digit growth rates. China is expected to grow at a 7 per cent rate this year, according to the World Bank – well off its previous pace, though much faster than expectations for growth of 2.8 per cent in the U.S. and 1.8 per cent in the EU. And even these anemic figures may overshoot the reality, considering that the slowdown is global in nature and perhaps already underway.
But slower economic growth – and thus lower demand for petroleum, the chief source of energy for industrial production and transportation – is only one part of the story. It's the impact of simultaneously falling demand and increasing supply that is driving the price of oil down so far and so fast.
To understand how the world economy got to this point, it's worth going back to just before the Great Recession of 2008, when oil was selling at $144 a barrel.
At that price, the biggest oil-producing states – Saudi Arabia, Venezuela, Nigeria, Russia and a handful of others – were flush with cash. Saudi Arabia, with its vast and cheap-to-extract oil reserves, was able to sock away $750-billion in foreign currency reserves and to easily sustain spending on subsidized housing and energy for its citizens, which has been crucial to the kingdom's ability to buy social peace.
In the U.S., consumers were grumpy about the high price of a gallon of gasoline, but U.S. energy firms smelled opportunity. Soon, people living in Pennsylvania, South Dakota and Texas were smelling a different side of that ‘opportunity’ – in the form of gas and toxic chemicals released by hydraulic fracturing for oil and natural gas that also tainted local water supplies.
After the Great Recession hit, oil prices crashed to $34 a barrel in December 2008, but they didn't stay low for long. By February 2011 – just over two years later – oil again entered $100-a-barrel territory. With China's growth churning on, a boom in other developing countries, and fears about possible disruptions to Middle East oil supplies in the wake of the Arab Spring, the price of crude kept climbing.
Oil analysts thought that rising demand would keep the price above $100 a barrel for years to come – and maybe oil would never again fall below that threshold if diminishing world oil supplies fell behind growing demand (the so-called peak oil theory). The new oil rush was on.
As left-wing economist Michael Klare explained, oil producers the world over were tapping supplies that had never before been considered profitable:
“Domestic U.S. crude production, which had dropped from 7.5 million barrels per day in January 1990 to a mere 5.5 million barrels in January 2010, suddenly headed upwards, reaching a stunning 9.6 million barrels in July 2015. Virtually all the added oil came from newly exploited shale formations in North Dakota and Texas.”
This was, in fact, the realization of the Obama administration's push for U.S. “energy independence.” Indeed, as a result of the massive increase in U.S. fracking operations, the U.S. is now second only to Saudi Arabia in terms of oil output.
Canadian output also expanded on the basis of new investments in tar sands oil extraction – from 3.2 million barrels per day in 2008 to 4.3 million barrels six years later. Costly offshore production was also yielding new supplies off Brazil and West Africa, while production in Middle Eastern oil fields in Iraq also ramped up by almost 1 million barrels per day.
Start of the Oil Price War
By 2014, all of this new supply had come online around the same time, Then, in late November 2014, came the shocker. Even as prices were already falling, Saudi Arabia, the world's leading oil producer, announced it would not cut back production, as had been expected, in order to put a floor under the fall in prices.
The Saudis' reasoning was simple: Because it's relatively uncontaminated and easy to extract, Saudi oil costs about $10 a barrel to produce, compared to an average of $36 a barrel in the U.S. (and a lot more in some places), $41 a barrel in Canada, $49 a barrel in Brazil and $52 a barrel in the UK. Lower prices would diminish overall profits for Saudi Arabia, but they would have the effect of driving other producers out of business, ultimately restoring a greater market share and greater overall mass of profits for Saudi output.
Thus began the great oil price war – and where it ends, nobody knows.
Between June 2014 and January 2015, oil prices fell by more than 50 per cent. Investors and energy companies vented about Saudi Arabia's unwillingness to prop up prices by curtailing production, but the U.S. oil industry was “blaming the Saudis for a problem that was created here,” oil executive Sarah Emerson told Bloomberg Business. “It's like a gold rush. Everyone is trying to get as much out of the ground as fast as possible.”
The statistics bear out Emerson's point. Saudi Arabia's contribution at that time to growing oil supplies was an additional 80,000 barrels a day, whereas U.S. producers had cranked up output by 694,000 barrels a day. Now with lower prices starting to take a bite out of production, U.S. output may be down by 1 million barrels a day – but that decline is being offset by new supplies elsewhere.
International sanctions on Iranian oil are being lifted as a result of its nuclear deal with the U.S. and other major powers, and that will add between 400,000 and 1 million barrels a day to global supplies. Iraq is also planning to increase output to generate desperately needed revenues. Plus Saudi Arabia and other Gulf countries may further increase production to compensate for diminished income from lower prices. As a result, financial analysts are debating whether the oil glut will keep prices below $50 a barrel until 2016, 2017 or 2020 and beyond.
Winners and Losers
One year ago, with the price of oil in the midst of a 50 per cent slide to under $50 a barrel, it was relatively straightforward to sort out the chief winners and losers of the global oil crash. Some $590-billion that would have gone to OPEC countries would instead stay in the chief oil-importing countries, including the U.S. and Europe.
In the U.S., one effect of the oil price plunge would be the equivalent of a $750 tax cut for every U.S. worker, leaving room in personal budgets for other purchases that would stimulate economic growth. U.S. corporations also hoped to fatten their bottom lines with cheaper energy costs, especially in the transportation and other energy-intensive sectors.
But the depth of the plunge since has produced a more complicated effect, as economist Jared Bernstein explained:
“That shale boom...has made us more of a global player, as the United States has doubled its domestic oil production since 2008, with the boom adding 3 million barrels per day to a global market that consumes 94 million per day. So although we're still a net importer, a lot more jobs, families and towns are now engaged in energy extraction.”
Already by September 2015, the oil price crash had led to 86,000 job cuts in the U.S. – forcing hard choices on families caught in the collapse.
Jason Butt considers himself lucky. Last year, he found out he had brain cancer and is now recovering from surgery. Butt works at Pioneer Oil Company based in Billings, Montana, but unlike 20 per cent of his coworkers, he still has a job – albeit with a 10 per cent pay cut. “It's made life a little bit tougher, especially with being a father of four kids,” said Butt. “It's been pretty stressful wondering whether we will be able to survive through this tough time.”
The Federal Reserve Bank of Dallas had been forecasting a 1.4 per cent increase in jobs this year in Texas, but now the picture has changed. “The biggest risk to the forecast is if oil prices are in the range of $20 to $30,” said Dallas Fed senior economist Keith Phillips. “Then I expect job growth to slip into negative territory as Houston gets hit much harder, and greater problems emerge in the financial sector.”
The hard times for frackers are also dragging down the balance sheets of big U.S. banks. In mid-January, according to the Financial Times:
“Three of the biggest U.S. banks revealed the damage wrought by a plunging oil price this week, disclosing big jumps in costs for bad energy loans and fears of contagion in other portfolios. Citigroup, the fourth biggest by assets, said...that it had recorded a 32 per cent rise in non-performing corporate loans in the fourth quarter from the previous year, mainly related to its North American energy book. Wells Fargo, the number three by assets, said net charges came to $831-million in the period, up from $731-million in the third, mainly due to oil and gas.”
On a global scale, the fall in oil prices is taking a toll on the whole world economy. According to the Economist:
“Projects worth $380-billion have been put on hold. In America spending on fixed assets in the oil industry has fallen by half from its peak. The poison has spread: the purchasing managers' index for December, of 48.2, registered an accelerating contraction across the whole of American manufacturing. In Brazil the harm to Petrobras, the national oil company, from the oil price has been exacerbated by a corruption scandal that has paralyzed the highest echelons of government.”
Other oil-producing countries are being devastated. In Venezuela, inflation is running at more than 140 per cent, and the country has declared an “economic state of emergency.” For Venezuela's state-owned oil company, each $1 drop in oil prices means a loss of $685-million in annual revenue. To fix the hole in its state budget, Venezuela plans to raise gasoline prices to make up the difference, even as it cuts back on other subsidies. The right-wing opposition to President Nicolas Maduro, heir to the legacy of Hugo Chávez, smells blood.
In Nigeria, about 75 per cent of the budget is funded by oil sales, so the government may also have to cut its budget – at a time when unemployment is already pushing toward 10 per cent. In Russia, the combination of international sanctions and the fall in oil prices has led to a 50 per cent decline in the value of the ruble against the dollar – which could spell a deeper political crisis than President Vladimir Putin has yet faced.
But the social tensions created by the drastic fall in oil prices are nowhere more intense than in Saudi Arabia. According to the New York Times:
“With the country's oil wealth slowly dwindling, Prince Mohammad is looking for ways to cut the budget, find new revenue and energize the private sector. He and his aides have already taken steps that were long considered almost impossible politically, like raising gasoline prices. Price increases for electricity and water are in the works, as is a value-added tax, a radical step in a country that has no income tax. They are also considering selling other assets, like airports...
“With more than half of the Saudi population younger than 25, a recent study by the consultants McKinsey warns of a coming demographic bulge that will require creating almost three times as many jobs for Saudis as were created during the oil boom of 2003-13. Otherwise unemployment, estimated at 12 per cent, could soar, creating a potentially volatile political environment in a country that is near war-torn Syria and is engaged in fighting in Yemen, its neighbour to the south.”
Saudi Arabia has already introduced sweeping budget cuts for 2016 to rein in an increased budget deficit equivalent to 15 per cent of gross domestic product. And the strain on the kingdom's finances will likely affect its ability to underwrite regional allies, like Egypt. In recent years, Saudi Arabia has transferred billions in cash and oil to buttress Egypt's battered economy. If that support dries up, the Egyptian military regime of Abdul-Fattah el-Sisi could face new and more severe challenges. For now, Saudi Arabia is maintaining its various commitments by burning through its $750-billion in cash reserves at a rate of $5 to $6-billion a month, which is unsustainable for very long.
Consequences for the Planet?
If the rout in the price of oil is dimming global economic prospects at an already fragile moment, the consequences for the planet are even more dire. Low prices provide little incentive for political leaders or corporate executives to invest in switching to sustainable energy sources. Previously, the huge revenues generated by triple-digit oil prices could have been used to pay for massive investments in renewable energy and to hire millions of workers at good wages to build a new renewable energy infrastructure.
But the unplanned, anarchic character of capitalist markets undermines any attempt to rationally plan for such a massive transformation in the production and consumption of the world's energy supply. Instead, the contradiction under capitalism between, on the one hand, socialized production that draws together the labour of millions on a world scale, and on the other, private accumulation by energy corporations exacerbates the problem.
This explains why the world has lurched from tight supplies and high prices a few years ago to overproduction on a massive scale and a crash in oil prices. The oil price war may ultimately drive out more costly production and restore profitability – but at the expense of corporate bankruptcies that destroy the livelihoods of the workers they employ.
More than a century ago, Karl Marx explained how capitalism invariably gives rise to an irrational situation, where too much production leads to a crisis for the system as a whole:
“There are not too many necessities of life produced, in proportion to the existing population. Quite the reverse. Too little is produced to decently and humanely satisfy the wants of the great mass...There are not too many means of production produced to employ the able-bodied portion of the population. Quite the reverse...[N]ot enough means of production are produced to permit the employment of the entire able-bodied population under the most productive conditions, so that their absolute working period could be shortened...
“On the other hand, too many means of labour and necessities of life are produced at times to permit of their serving as means for the exploitation of labourers at a certain rate of profit...i.e., too many to permit of the consummation of this process without constantly recurring explosions...Not too much wealth is produced. But at times too much wealth is produced in its capitalistic, self-contradictory forms.”
The only hope for ending this irrationality is to replace the profit motive and capitalist markets with production for need, based on democratic, socialist planning. Until then, fasten your seat belts. The oil price war will make for a bumpy ride. •
Eric Ruder writes for the Socialist Worker, where this article first appeared.