Oil Dependent Countries Suffer as Glut Rages On – 12/04/15

As crude-oil futures fall below $40 a barrel, oil dependent countries relying on sales of the commodity to balance their books are squeezed by prices that have fallen below half of 2014 levels with no sign of a bottoming out. Oil revenue reliant countries, such as Venezuela, Russia, Saudi Arabia, and a multitude of others in South America and the Middle East, are seeing large budget deficits in the wake of weak demand and resiliently high output.

Since the deceleration of China’s economy began this Summer with a plunge in its stock market, the country’s demand for oil has fallen significantly. The Chinese government is attempting to use policy to maintain the 7% growth rate from previous years but will likely fail by even its own metrics as looming demographic and economic issues weigh on the nation. By extension, many commodity driven economies like those of Brazil and Australia also face slowdowns as China cuts orders for raw materials. Coupled with increased fuel efficiency, eased sanctions against Iran, a strong dollar, climate talks calling for decreases in fossil fuel usage, and the increasing cost-efficiency of alternative energy/electric vehicle systems, the slowdowns continue to weaken global demand.

Oil outputs remain high in spite of lower demand and unprofitable oil prices. In an attempt to force out smaller producers in the US, Saudi Arabia drills to maximize output in spite of OPEC discontent with the oil glut. The issue will likely not be resolved by pressure at this year’s meeting. The smaller producers in the US are proving to be more stubborn than anticipated as they continue to keep output high to maximize their cash flows.

Their creditors are also proving unexpectedly robust as the cuts to credit lines are well below expectations of industry executives. Shale oil available via fracking technology has greatly reduced the influence OPEC can assert with output reductions. Russia and Iran competing for market share, especially in Europe, have refused outright to rein in output and pump at record levels while analysis funded by OPEC has indicated that even with reduced output the market faces significant overproduction due to non-OPEC entities and bulging stockpiles. Saudi Arabia and Iran head opposing sides reflecting their competition for influence in the destabilized regions of Syria and Yemen. OPEC has long been plagued by free rider problems as countries within the group pump past output ceilings and major producers outside the group maximize output in order to maximize revenues even as prices collapse.

For many years, the ruling party of Venezuela relied on oil revenues to maintain their legitimacy. Now, with collapsed oil prices, the United Socialist Party is unable to use income from the state-owned oil companies to provide the cheap food, housing, and services that won over voters. Even with the lack of information provided by the government, food shortages and the collapse of many state welfare institutions make it apparent that the country is facing serious economic woes revealing decades of oil reliance has left the populace with few alternatives to government programs. Dominance over the media and the reliance of many on government jobs and welfare are among the many tools the ruling party will use to contain opposition in the upcoming elections.

In Russia, the price collapse has made a recession all but certain as oil and natural gas account for over 2/3’s of export revenues. The combination of low prices, wars abroad, Western sanctions, a shrinking populace, and rampant corruption weigh down the nation’s prospects and the Russian government shows plans to help stabilize prices or pull back from other costly engagements. Conflicts with Ukraine, the West, and now Turkey have put the Russian leader Putin into a position where his government needs the oil revenues to fuel military production and combat a looming budget crisis.

In the US, the Federal Reserve prepares to raise interest rates for the first time since the 2008 crisis. The strong dollar has increased demand for foreign goods as relatively cheaper imports and increased employment have led to increased consumption but do not offset the effects of the output from US shale oil and natural gas deposits as they add to an oversupplied oil market. In recent times, US firms have used to these new sources and other advances in technology and capital streams to maintain a larger production base less susceptible to attempts by OPEC members to price these smaller, higher-cost producers out of the market for significant time frames.

The Paris Climate talks have shown the contention between developed and developing countries over the future costs of fossil fuel usage. Countries such as India question how they could grow without the cheap energy that other nations had access to and ask for financial help be given if they are expected to shift to more costly green energy sources. The effects of climate change are to be most costly for less developed countries that do not have the means to deal with shifts in shorelines and more volatile weather.

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