December 7, 2014

The drop in gasoline prices since June is currently saving US consumers approximately $400 million a day. Other than those lower pump prices, what are the ramifications of lower oil prices?

To some extent, the implications of lower oil prices are a function of their cause. Oil is currently experiencing a perfect storm of increased supply and, thanks to weakening economies, softening worldwide demand.

Consumption of oil in North America has been in structural decline for 15 years. Economic growth in China is muting, as is its oil consumption. Most of Europe remains weak. And after earlier official Russian forecasts of 1.2 percent growth in 2015, the Russian Economic Ministry is finally admitting that it expects to be in full-fledged recession next year. It also forecasts nine percent inflation.

The Russian situation is especially volatile.

Immediately following the Russian economic forecast last week, the Russian ruble fell five percent against the dollar, bringing its full-year decline to more than 40 percent.

The Russian government earns half of its revenues from the sale of oil and natural gas. The 2015 Russian budget is based on $80 a barrel oil; some analysts are predicting prices as low as $40.

Following Vladimir Putin’s annexation of Crimea in March, the US and other Western countries imposed a number of economic sanctions against Russia, including limiting financing support to six of the country’s largest banks and four of its energy companies.

Russia was expected to mostly shrug off the effort, as it could rely on its strong oil revenue and strategic role in supplying natural gas across most of Europe.

But Putin wasn’t expecting a collapse of oil prices. Even with no further decline, current oil prices will produce a massive Russian budget deficit. It is also causing a massive shift in wealth from net oil exporters (primarily OPEC members) to the world’s net importers, the largest three of which are China, India and the US.

Yardeni Research estimates that the 40 percent drop in prices since June will result in an annual revenue decline of $1.5 trillion to the world’s largest producers, including Russia. That’s $1.5 trillion that the world’s importers won’t be paying.

Higher oil prices solves a number of Putin’s problems. But he needs help in making that happen. Because of their low cost of production, the Saudis are in the best position to profitably reduce their output.

They also show little appetite for doing so.

Not only are there no guarantees with respect to oil prices, few people even have a decent history of good guesses. While prices have fallen from more than $100 a barrel to below $67 this year, prices have ranged from $145 to a low of almost $30 since 2008.

Oil prices are anything but stable, as are their role in geopolitical events.