By Muzaffar Khan Waris

Edited by Shambhavi Singh, Senior Editor, The Indian Economist

Black Gold has invoked many battles during the course of human history, many more than currency and Gold could provoke. With the rapid development all around the world, the need for oil is becoming much more imperative. Ever since the oil crisis of 1973, OPEC has been controlling the global oil and gas economy by forming a cartel which effectively determines the prices of crude oil by manipulating the market either through increased or decreased production of oil. Whenever there is a glut in the economy, they increase the supply of crude oil. Thus, it brings the price down, and maintains the classic demand supply ratio. However, the general trend over the many decades after the oil embargo has been fairly bullish in terms of oil prices, barring a few gluts in the global economy. The recent fall in global crude oil prices forms an interesting event in the world economy and could be remembered as a historic event; the crude oil prices touching $120/bbl. In 2013, the price started falling drastically after September 2013 and has fallen more than 20%. Currently as it stands on mid-October, the future prices on ICE are trading at a price $83.78/bbl.

The papers have been abuzz with the news of such an essential commodity experiencing a drastic downturn. Many attribute it to the universal glut in the major economies in the world, such as China, Europe and Japan. Some blame it on Uncle Sam and its magic wand creation of shale oil and gas which has made USA less reliant on foreign import, thus, causing an oversupply of crude oil in the market and hence, making its price take a tumble. Before going into the alleged controversy let me explain the importance of crude oil from an economist’s point of view (crude oil is being referred to as oil from here on), as many people unfamiliar with the properties of crude oil (I too have very little knowledge regarding the diverse utilities of crude oil) think of crude oil just as a raw material whose refined product such as diesel, petrol and kerosene are an important source. There is much more to crude oil that just gasoline and diesel, crude oil or its by-products are used all around the world in almost every industry. Crude oil is similar to the Pandora’s Box. The world’s crude oil production stands at 92 million barrels per day, out of which OPEC contributed nearly 30 million barrels. Up until the shale gas revolution, OPEC was maintaining the global oil and gas market and feeding its largest customer USA a massive 20 million barrels a day, but with the shale revolution the USA demand for oil and gas have gone down drastically and it imports only around 7 million barrels from outside and rest is produced domestically.

OPEC is a classic example of Oligopoly; they work in a mutual agreement with each other and maintain the interests of countries that are part of the cartel. With USA increasing its production, and even threatening to export in the near future, the cartel is suddenly vulnerable forcing them to look eastwards towards India and China to off take their products. Unlike USA which is a developed economy and is involved in trade of many other commodities, the economy of Saudi and other OPEC countries are heavily dependent on crude oil exports. If crude oil market becomes over flooded with oil produced in Non-OPEC countries, the trade balance of OPEC countries will be in a huge trouble.

This is where I think Saudi Arabia and other OPEC countries have started working on a well-designed plan. With lowering economic growth worldwide, the normal course of action for the OPEC countries is to cut production and induce the demand to pick up. Hence, they maintain a favourable price. However, this time it is not that simple; Saudi has rejected the plea of Venezuela of holding a meeting immediately to foresee the future action plan and is also not willing to cut the production level. The strategy adopted by Saudi can be classified as “HOLD YOUR BREADTH INSIDE WATER TO SEE WHO LASTS LONGER”. By allowing the price of crude oil to free-fall, Saudi and other OPEC countries are harming themselves too, but they are ready to take a body hit in return of destroying the market of USA. The current boom in oil and gas production is USA is due to shale, and according to many analysts the production of shale will become unviable and newer exploration activities won’t be possible if the prices keep on falling. Thus, Saudi is ready to see a price cut below $80/bbl at the expense that USA is forced to stop shale extraction so that once again the cartel becomes the major force behind the market.

The ongoing fight between the two powerful groups is nothing short of the plot from the movie “Godfather”, where two cartels fight over the right to rule. It is an exciting in world politics and for the CONSUMERS. They are the  biggest beneficiaries of price wars. The cut throat battles have already resulted in the fall of prices of gasoline and diesel. Under recovery in India has turned into over recovery in a matter of months and other products related to crude oil such as automobile and paints are also seeing a sudden rise in their demand. As the saying goes, “One man’s loss is another man’s gain”.

Posted by The Indian Economist | For the Curious Mind