1. A delicious, organic beverage
In early 2014, the average oil price around the world was more than $100 per barrel, having hovered between $100 and $120 for pretty much all of the previous three years. In 2015 it’s as low as $45, the lowest price since Wall Street descended into chaos back in 2009. “Sweet, cheap gas” you might say… if you were American. People elsewhere might say “Sweet, cheap petrol”, while other people might not favour the term “sweet” at all, despite “Sweet Crude” being one of the main types of oil traded in the world market.
If you’re the curious type, crude oil is considered “sweet” if it contains a relatively low amount of sulphur. Nineteenth century oil prospectors would taste and smell oil to determine its qualities, and the taste of low sulphur oil is actually somewhat sweet. A delicious, organic beverage that won’t cause diabetes (but may result in other health problems).
Ok, let’s focus.
“Good, cheap fuel”, you might say. And you’d be right. Low oil prices do indeed point to cheap fuel. But when there’s a major price fall in something, there are always going to be both winners and losers. People are paying less money for something, but there will also be people who will be earning less money because of that. I’ll set the scene here.
2. What’s oil used for?
A lot more than putting in a car. Pretty much everything that contains plastic or chemicals was made using by-products from oil. Also, food that was grown with pesticides or fertilisers. And anything produced by a machine that required lubricant to operate. And pretty much anything that was transported in a truck, ship, or plane. Oh, and the asphalt for that roads are made out of. It’s actually pretty tough to think of things that oil ISN’T used to produce or transport.
So when the price of oil goes sharply up or down, there’s a broad ripple effect from that sudden shift in prices.
3. Who decides what the oil price is?
In a normal situation, it’d mainly be decided by supply and demand. When the world economy is going well, oil prices tend to be high. Factories are producing lots of products; trucks, ships and planes are making lots of trips, and a lot of oil is required to make this happen. If there’s a set amount of oil being produced each day, the competition is hot for customers to get their hands on it, because lots of people have profitable things that they could do with the oil. Those high prices are also going to motivate oil producers to find ways to produce more oil.
On the flipside, when times are bad in the world economy, and demand for products and services is lower than normal, there will tend to be weaker demand for oil, and you won’t have to pay as much to buy a barrel of it. When oil prices are low, it’s not always worth the while of the oil producers to find oil, drill for it, and sell it.
4. A little bit about OPEC
That all sounds logical enough, but there’s an extra layer of intrigue when it comes to the world price for oil. A few decades ago, some major oil producing countries joined together to form an organisation called OPEC. These twelve countries currently possess 80% of the world’s conventional oil reserves, and produce around 60% of the world’s internationally traded oil. Producing and selling oil is a big deal for these countries, and one of the key goals of OPEC is to keep the price of oil stable at a good level for its member countries. The countries in OPEC are: Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. As you can see, these countries are a mix of rich and poor, and are located in different parts of the world.
Because OPEC countries account for such a large slice of the international oil business, their behaviour can influence the world oil price. If they consider that the price is too low, they can work together to cut back the amount of oil they produce, so that the product becomes scarcer in the market, and the price goes up. If the price is high, OPEC countries can work together to produce more oil, and take advantage of the large number of customers willing to pay profitable prices.
People use negatively-loaded terms like “cartel” to describe OPEC, because OPEC does indeed manipulate the market price of oil to suit itself. But while not all of their decisions have been made with the world’s best interest in mind, I can accept the general idea that these countries want to capitalise on this one big opportunity to prosper. They got lucky by being located on top of gigantic oil deposits, and they want to make the most of it.
Overall, the world oil pricing system has worked reasonably smoothly in recent years, so the sudden crash in the oil price in 2015, despite there being no major crisis in the world economy, begs the question “why is it happening, and what’s OPEC up to?”
5. Why has the price crashed now?
Short answer: The USA. Long answer: The United States of America (and kinda Saudi Arabia and China).
New oil drilling methods have unlocked previously hard-to-affordably-reach oil deposits in the US. Back in 2005, the US relied on imported oil for 60% of its domestic needs, and that is expected to plunge to only 21% this year. Basically, the US is producing a LOT more of its own oil, and requires far less from big oil producers overseas. With the biggest oil customer in the world currently in the process of disappearing from the market, and as a result the price of oil is crashing. OPEC has now lost its grip on setting the world’s oil price, and the OPEC countries are arguing amongst themselves.
Saudi Arabia is the biggest oil producer in the OPEC group, and is able to produce oil at a lower cost than most of the other countries. Rather than reducing its production level to stop the price from falling far below its recent levels, Saudi Arabia has largely continued to produce at high volume, because its low production costs enable it to still turn a profit at the lower market rates. Numerous other OPEC countries haven’t been too impressed by this strategy, because traditionally the group had been united in its strategy.
The China bit in my short answer refers to China’s rapid economic and industrial growth in recent decades. The nation has had a very big appetite for things like coal, oil, and steel, as it has transformed itself into “the world’s factory”. The Chinese economy is still growing fast by world standards, but by its own recent standards, 2015 hasn’t been strong. Because China has been underperforming, the global demand for oil isn’t quite as high as most pundits predicted.
6. What happened to “Peak oil”?
A few years ago when oil prices were really high, this “peak oil” term was on everyone’s lips. Peak oil refers to the fact that there’s a limited amount of oil under the earth’s surface, and that we’re using it up pretty fast. The “peak”, is the moment in time when it starts running out… after which we won’t be able to extract and produce oil in the quantities that we used to. The story goes that oil will become really scarce, really expensive, and we’ll all be in really trouble.
It’s not in the papers as much at the moment, but peak oil is still coming. The new drilling methods that let us reach “unconventional oil” reserves have probably pushed the date of peak oil back a bit, but most estimates still have peak oil happening in the next few years. Longer term planning for life after abundant oil is going to have to take this into account, but right at this minute, the plunging price of oil suggests that we’re hardly in shortage mode.
Finally, I need to quickly talk about “peak beard”. On the night I first met my lovely girlfriend, she alleged that society was reaching “peak beard”, and that they would soon vanish. Clutching my beard nervously, I told her that she was WRONG. And she was wrong; 16 months later, the world’s beards are alive and well. Take that. Unlike the inevitability of peak oil, beards are renewable, sustainable, and will live forever.
7. Ok, back to who’s winning and who’s losing
Beards are winning. But on the topic of oil, there are several ways we can look at the winners and losers. We can either split them up by countries, by income level, or by the consumption patterns of individual people. Let's have our cake AND eat it by sizing up all three of these angles.
8. Places that are winning!
If you’re not a major oil producer, you’ll be loving the price drop. Most of Europe will be thrilled, with Norway and the UK the only European countries turning oil serious amounts of oil. Europe’s developed countries use a lot of oil, so they’re saving billions.
At the other end of the spectrum, it’s also helping a lot of African and Asian countries, too. Four out of five African countries don’t produce oil or gas, and many of these countries are low income nations who have to dig deep to afford the oil to keep their economies ticking over. Lower oil prices will free up money to (if the governments choose to use it for this) build infrastructure and implement social programs to help people lift themselves out of poverty.
Even though countries like the United States and Canada are some of world’s largest oil producers, overall they’re arguably winning from the crash in oil prices. New “unconventional” oil production in the US has broken the stranglehold that OPEC had on world oil production, and has strengthened the US hand in global strategic politics. Also, as some of the world’s largest consumer economies, everyday people are paying less for everyday products.
9. Places that are losing
The opposite, really. Most of the world’s major oil producers now have major holes in their national budgets. Wealthier countries that produce a lot of oil are likely to have a cash buffer that can tide them over if the price drop is only temporary, and countries with diversified economies (as in, they produce lots of other stuff too) won’t be left as vulnerable to the price drop.
Which major oil producing countries aren’t wealthy overall, and don’t have diversified economies? Plenty of them are in Africa, South America, and the Middle East. Countries like Brazil, Venezuela, Angola, Nigeria, Russia, Iran, and Iraq . Each of these countries rank among the world’s top 17 oil producing countries, and their governments rely on tax from producing oil. When the world oil price falls sharply, the amount of tax money falls with it, and oil-dependent governments find themselves in a mad scramble to find ways to pay the bills.
Venezuela is a stark example of this, with recent radical socialist governments all but shutting down other industries that were exporting goods overseas. In 2013, over 96% of Venezuela’s exports were petroleum products, and 45% of the government’s income comes from oil taxes. So if the oil price falls by half, is the country in big big trouble? You betcha.
In these circumstances, governments can become unstable and start making desperate short term moves in order to balance the books. This can then cause social unrest, hardship, and potentially conflict.
10. What it means for the world's poor
So as you can see, it’s not quite as simple as “low oil price = good (or bad) for the poor”. If you’re a person living in poverty, it really depends on what country you happen to be living in. I wouldn’t want to be a poor person in Angola or Venezuela right now, but there’s every chance that cheaper oil is improving the standard of living of people living in extreme poverty in India, which has to import virtually all of its oil from overseas.
One of the less obvious ways in which oil prices affect the poor (who are less likely to drive cars, go on flights, or have high levels of general consumption) is in the form of food prices. The cheap oil has coincided with cheaper food prices, with it suddenly being much cheaper to manufacture and transport food.
If you’re a person living in poverty in an urban area, it’s likely that cheap oil makes it cheaper to eat. If you’re living in a rural area and grow much of your own food, it’s not going to have as much of an impact. But with a massive global migration underway from rural areas to cities (over 50% of the world’s people live in cities now, and that’s expected to be pushing 70% by 2050), global poverty is becoming more and more a story about the conditions in urban areas.
11. But is cheap oil the point?
In the long run, not really. Prices of commodities like oil fluctuate from year to year, and it’s almost certain that oil prices will swing back upwards in the years to come. While cheaper oil is granting temporary relief to people living in poverty in various parts of the world, it’s almost a distraction from the bigger task of transitioning the world away from fossil fuels and towards renewable energy.
We know that the world’s oil supply isn’t infinite, and we’re now entering an era where we have viable technology to reduce our reliance on it. Solar panels and wind turbines are getting more efficient at capturing energy, we’re developing better ways to store energy, and hybrid cars now have the range and performance to get the job done.
Normally when a community/nation increases its standard of living and moves out of poverty, the increased economic activity will mean increased energy consumption. That’s an environment versus development dilemma that is sometimes talked about, but by helping countries to develop in environmentally sustainable ways, we can have the best of both worlds.
Ideally, when the oil price goes back up, we can have programs in place that can prevent people from slipping back into poverty. By working to diversify economies (encouraging innovation and new industries), reducing reliance on fossil fuels, and investing in good governance and social programs, we’re in with a chance.