Stacks and burn-off from the Exxon Mobil refinery are seen at dusk in St. Bernard Parish, La., Friday, Feb. 13, 2015.

Stacks and burn-off from the Exxon Mobil refinery are seen at dusk in St. Bernard Parish, La., Friday, Feb. 13, 2015. Gerald Herbert/AP

How Cheap Oil Is Reshaping Global Hotspots

From Russia to your local gas station, the consequences of low fuel prices are clear. But the second and third order effects are only beginning to become apparent.

What do Russia, Exxon Mobil, and ISIS have in common? Not much, except that they’re all grappling with an inconvenient but incontrovertible truth: a sudden, significant, and prolonged shift in the price of oil changes the world.  

That truth was on display in 1974, and it’s on display again now. Over the course of just a few months in 1973-1974, the price of oil surged from $3 to $12 per barrel. The new price created new global economic powers: oil-producing countries primarily in the Middle East and North Africa. It also dealt a severe blow to the economies of the United States, Europe, Japan, and other oil importers. The oil shock altered power relations between the world’s main geopolitical players and created new ones. Higher oil prices had many unexpected consequences—from breeding oil wars to fueling theinternational spread of Islamic fundamentalism thanks to funding from newly super-rich countries like Saudi Arabia. Today’s drop in crude-oil prices, which began in the summer of 2014, may be as disruptive as the quadrupling of oil prices that created the oil shock of 1974.

Some of the effects of this decline in oil prices have been clear and immediate; picture happy Americans at gas stations and frantic government officials in oil-exporting countries forced to cut public budgets and consequently risk social and political turmoil.

In Russia, for instance, the ruble has suffered a steep devaluation, stock-market prices have fallen, the Central Bank’s reserves are shrinking, capital is fleeing the country, export revenues are down, and foreign investment has practically dried up. Russia’s sovereign bonds have been downgraded to junk status by credit-rating agencies. All of this largely stems from contracting oil and gas revenues (which account for 68 percent of Russia’s total export revenues and 50 percent of its federal-budget revenues) and economic sanctions imposed by the United States and Europe as a result of the Kremlin’s behavior toward Ukraine. Some fear that a belligerent Vladimir Putin could stir trouble abroad to distract from the deteriorating economic situation at home.

In Venezuela, the economy was already in shambles when oil was at $120 per barrel, and it’s now spinning out of control as a result of rampant corruption, woeful management, and lower oil prices. President Nicolas Maduro has responded by blaming the dire situation on a U.S.-led international conspiracy and ramping up repression of critics and opposition politicians.

But these direct consequences are having consequences of their own, and these second-order effects are only beginning to become apparent. In December, Chevron canceled a $10billion shale-gas exploration project in Ukraine, which the Ukrainian government was counting on to help stimulate its troubled economy and, eventually, lower its dependence on Russian gas. It’s just one example of a broader, industry-wide trend: scrapping or postponing energy projects that have suddenly become too risky or not economically viable at a lower oil-price level. According to Goldman Sachs, $1 trillion worth of investments in energy projects could now be at risk. In the long run, this may mean less oil production and higher energy prices. But in the short run, the abrupt disappearance of this enormous investment flow is bound to hurt energy companies—and especially their equipment suppliers and the construction and engineering firms that were planning to execute these projects. It will also hurt the cities and regions, from Texas to Lagos, where these companies operate.

Not all of the second-order consequences of lower oil prices are negative. Consider this comment from a recent International Monetary Fund report on Malaysia’s economy:

After raising electricity tariffs in early 2014, [the government] took advantage of lower energy prices in the second half of 2014 to reduce and ultimately remove remaining gasoline and diesel subsidies. … [Subsidy reform should] help broaden the base of [the] federal revenue system and diversify it away from volatile oil and gas revenues. A strengthening of Malaysia’s social safety net is an integral part of the authorities’ fiscal strategy. The removal of subsidies freed up resources that can be redirected to better support poorer households through better targeted cash transfers.

Countries from Oman to Indonesia have undertaken similar campaigns to scale back or  eliminate fuel subsidies. In India, the Modi government cut costly public subsidies of diesel fuel, which were long understood to be counterproductive but were nevertheless politically unpopular to shed. Energy subsidies, which amount to more than $540 billion per year worldwide, are as common as they are damaging to economies, the poor, and the environment, since they stimulate consumption and undermine efforts to save energy and use it more efficiently. According to the World Bank, these subsidies are highly regressive: As much as 60 or even 80 percent of what governments in the Middle East and North Africa spend to subsidize energy benefits the richest 20 percent of the population, with the poor receiving less than 10 percent of these public funds.

Lower oil prices could also reduce incentives to produce the kind of extra-heavy, extra-polluting oil that is found at some of the world’s largest oil reserves, including those in Venezuela’s Orinoco river region. Due to the high production and upgrading costs associated with heavy oil, the development of these reserves is likely to be postponed. The problem is that low oil prices are eroding the economic viability of cleaner energy sources like solar and wind. Optimists hope that plummeting oil-and-gas prices will encourage producers of renewable-energy sources to improve their technologies and production methods, making these sources cheaper and more economically viable. This, in turn, could make renewable energy more commercially attractive once the price of oil rebounds.

Financial markets, too, are being reshaped by the cost of crude. Falling prices can harm the balance sheets of energy companies by driving down the volume of proven reserves that these corporations can count as marketable assets—reserves, mind you, that are one of the main drivers of the market value of these companies. As oil prices drop, the increasing production costs of some oil reservoirs will make these reserves commercially unviable. Such reservoirs will become a new kind of “stranded asset,” a term coined to describe fossil fuels that will not be used as climate-change concerns lead governments to stimulate alternative-energy sources and make the consumption of hydrocarbons more expensive. Upheaval in corporate valuations could lead to a wave of mergers and acquisitions among energy companies, transforming the structure of the industry.

Meanwhile, some of the world’s largest sovereign-wealth funds—or state-owned investment vehicles—belong to oil-and-gas producing countries. The Norwegian fund, for example, owns about 1.3 percent of all global securities. A prolonged depression in oil prices might force Norway to finance its fiscal shortfall with resources from its sovereign fund. This would entail the liquidation of sizable investments, and thus exert downward pressure on global equity markets. In fact, Norway’s $840-billion fund has already set up an expert group to evaluate whether it should stop investing in fossil-fuel companies, in anticipation of hydrocarbon assets losing significant value.

In the geopolitical realm, the relationship between Russia and Europe has already been disrupted, both by low oil prices and the conflict over Ukraine; the cancellation of Gazprom’s South Stream pipeline across the Black Sea and Southeastern Europe is just one manifestation of the evolving energy equation in the region. Russia’s relationship with China is also in flux. Matt Ferchen of Beijing’s Carnegie-Tsinghua Center for Global Policy envisions closer economic cooperation between the two large nations: “China’s calculations in terms of energy deals hinge on a more advantageous bargaining position over the price of oil. … Russia, now under fire from sanctions and a drop in commodity prices, therefore needs a partner.”

In Latin America and the Caribbean, Venezuela’s political influence is waning as a result of many factors, paramount among them that the Bolivarian government no longer has the flush oil revenues that allowed Hugo Chavez to gain enormous influence by subsidizing oil supplies to friends and denying those supplies to foes. Countries that have been dependent on its largesse will have to look for alternatives, which might require engagement with other political forces in the hemisphere. The collapsing price of oil played a role in the recent rapprochement between Cuba and the United States. Venezuela’s economic crisis heightened the risk that Havana would no longer be able to count on the enormous subsidy it has enjoyed for more than a decade from Caracas. The Cuban regime was thus eager to find another source of economic support. It found one in America.

Nowhere are the second-order consequences of cratering oil prices more varied, important, and unpredictable than in the Middle East. In a Financial Times article in February titled “ISIS struggles to balance books as finances are squeezed,” reporter Erika Solomon wrote, “The world’s richest jihadi group is not as flush as it once was. It has cut spending on fuel and bread subsidies, while increasingly shaking down locals for cash. Fighters themselves may be feeling the squeeze, too.” Analyst Torbjorn Soltvedt estimated that the militant group’s revenue from selling oil had dropped to $300,000 per day, down from between $1 million and $2 million a day in 2014. “I don’t think [the oil-revenue decline] will lead to [the Islamic State’s] collapse. … But it might accelerate their implosion,” Soltvedt told Solomon. Iran, meanwhile, has entered into negotiations with world powers over its nuclear program for a variety of reasons. But the fact that Iran is one of the world’s hardest-hit oil producers is surely one of them.

All of these outcomes—both the direct and immediate, and the indirect and distant—hinge on two questions: How low will oil prices drop? And how long will this period of low prices last? Venturing answers is risky business; virtually no expert, corporation, or government anticipated the revolutionary drop in prices that began in the summer of 2014. But there are signs that the new normal could remain normal for some time. As Rex Tillerson, the CEO of Exxon Mobil, put it, “The world should ‘settle in’ for a period of relatively weak oil prices. U.S. shale production is more resilient than many people had expected and demand growth in China and elsewhere has slowed. Those conditions could persist.”

X
This website uses cookies to enhance user experience and to analyze performance and traffic on our website. We also share information about your use of our site with our social media, advertising and analytics partners. Learn More / Do Not Sell My Personal Information
Accept Cookies
X
Cookie Preferences Cookie List

Do Not Sell My Personal Information

When you visit our website, we store cookies on your browser to collect information. The information collected might relate to you, your preferences or your device, and is mostly used to make the site work as you expect it to and to provide a more personalized web experience. However, you can choose not to allow certain types of cookies, which may impact your experience of the site and the services we are able to offer. Click on the different category headings to find out more and change our default settings according to your preference. You cannot opt-out of our First Party Strictly Necessary Cookies as they are deployed in order to ensure the proper functioning of our website (such as prompting the cookie banner and remembering your settings, to log into your account, to redirect you when you log out, etc.). For more information about the First and Third Party Cookies used please follow this link.

Allow All Cookies

Manage Consent Preferences

Strictly Necessary Cookies - Always Active

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Sale of Personal Data, Targeting & Social Media Cookies

Under the California Consumer Privacy Act, you have the right to opt-out of the sale of your personal information to third parties. These cookies collect information for analytics and to personalize your experience with targeted ads. You may exercise your right to opt out of the sale of personal information by using this toggle switch. If you opt out we will not be able to offer you personalised ads and will not hand over your personal information to any third parties. Additionally, you may contact our legal department for further clarification about your rights as a California consumer by using this Exercise My Rights link

If you have enabled privacy controls on your browser (such as a plugin), we have to take that as a valid request to opt-out. Therefore we would not be able to track your activity through the web. This may affect our ability to personalize ads according to your preferences.

Targeting cookies may be set through our site by our advertising partners. They may be used by those companies to build a profile of your interests and show you relevant adverts on other sites. They do not store directly personal information, but are based on uniquely identifying your browser and internet device. If you do not allow these cookies, you will experience less targeted advertising.

Social media cookies are set by a range of social media services that we have added to the site to enable you to share our content with your friends and networks. They are capable of tracking your browser across other sites and building up a profile of your interests. This may impact the content and messages you see on other websites you visit. If you do not allow these cookies you may not be able to use or see these sharing tools.

If you want to opt out of all of our lead reports and lists, please submit a privacy request at our Do Not Sell page.

Save Settings
Cookie Preferences Cookie List

Cookie List

A cookie is a small piece of data (text file) that a website – when visited by a user – asks your browser to store on your device in order to remember information about you, such as your language preference or login information. Those cookies are set by us and called first-party cookies. We also use third-party cookies – which are cookies from a domain different than the domain of the website you are visiting – for our advertising and marketing efforts. More specifically, we use cookies and other tracking technologies for the following purposes:

Strictly Necessary Cookies

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Functional Cookies

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Performance Cookies

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Sale of Personal Data

We also use cookies to personalize your experience on our websites, including by determining the most relevant content and advertisements to show you, and to monitor site traffic and performance, so that we may improve our websites and your experience. You may opt out of our use of such cookies (and the associated “sale” of your Personal Information) by using this toggle switch. You will still see some advertising, regardless of your selection. Because we do not track you across different devices, browsers and GEMG properties, your selection will take effect only on this browser, this device and this website.

Social Media Cookies

We also use cookies to personalize your experience on our websites, including by determining the most relevant content and advertisements to show you, and to monitor site traffic and performance, so that we may improve our websites and your experience. You may opt out of our use of such cookies (and the associated “sale” of your Personal Information) by using this toggle switch. You will still see some advertising, regardless of your selection. Because we do not track you across different devices, browsers and GEMG properties, your selection will take effect only on this browser, this device and this website.

Targeting Cookies

We also use cookies to personalize your experience on our websites, including by determining the most relevant content and advertisements to show you, and to monitor site traffic and performance, so that we may improve our websites and your experience. You may opt out of our use of such cookies (and the associated “sale” of your Personal Information) by using this toggle switch. You will still see some advertising, regardless of your selection. Because we do not track you across different devices, browsers and GEMG properties, your selection will take effect only on this browser, this device and this website.