Navigant Research Blog

Oil Price Crash Rocks Producers’ Worlds

Richard Martin — December 22, 2014

The effects on U.S. consumers of the steep decline of oil prices in recent months have been very welcome: in mid-December, average nationwide gas prices dropped below $2.50 a gallon, leading some analysts to predict a very green and merry Christmas.

The geopolitical ramifications, however, are much less benign.  They can be seen most visibly in Russia, where the value of the ruble is collapsing and the economy is slipping into recession.  The impacts of a crippled economy, clobbered by plummeting oil prices and economic sanctions over the annexation of Crimea, on the government of Vladimir Putin are impossible to predict.  But Russia in chaos is not a good thing for international security.

The December issue of Navigant’s NG Market Notes examines the likely implications of the current price dive on the global oil and gas industry.  Below is a rundown on the consequences in three critical OPEC countries.

Venezuela

Plunging oil prices have deepened Venezuela’s economic crisis, bringing “massive shortages of basic goods, the world’s highest inflation rate, and a steep currency devaluation,” according to Bloomberg Businessweek.  The decline poses a serious threat to the government of President Nicolas Maduro, who has attempted to continue Hugo Chavez’s program of massive socialized welfare and subsidized prices.  In mid-December, Fitch Ratings downgraded Venezuela’s credit rating to “CCC,” which signals a strong possibility of default.  Low oil prices also deepen Venezuela’s dependence on China, which has lent some $40 billion to prop up the faltering Venezuelan economy through loans and other credits.  Venezuela now exports about 540,000 barrels of oil a day to China, most of which is unprofitable because it goes to repay Chinese loans.

Iran

Overruled at the November OPEC meetings in its bid to push the producing countries to cut production, the Islamic Republic of Iran has moved to the paranoid phase.  Oil minister Bijan Zanganeh declared, “The prolongation of the downward trend of the oil price in world markets is a political conspiracy going to extremes,” according to the British newspaper The Telegraph.  Iran’s currency, the rial, has lost 8% of its value against the dollar in recent weeks as Iran copes with not only plummeting oil prices, but also the crippling effects of economic sanctions from Western nations over its pursuit of nuclear weapons technology.  The impact is also being felt in neighboring Syria, where the Assad regime is propped up in the country’s 4-year-old civil war by support from Shi’ite Iran.  Iranian officials have insisted that support for Syria will continue.  But the steep price fall “will break Iran’s back, not just the level of support for Assad,” a Syrian businessman told Reuters.

Saudi Arabia

Perhaps the most significant effects of falling oil prices can be seen in the Kingdom of Saudi Arabia, the world’s biggest oil producer for decades until being overtaken by Russia and, more recently, the United States.  The Saudis, who can produce oil from their desert fields at a cost of as low as a few dollars per barrel, have calculated that, at least for the time being, they can endure the effects of very low-priced oil.  In so doing, they are choosing to price other, higher-cost producers out of the market.  Already, production in the North Sea and western Canada is jeopardized, although the common notion that the Saudis are waging a “war on shale” by making U.S. shale oil production uneconomical is probably wrong.  U.S. shale producers can still make money with prices as low as $30 a barrel, according to Morgan Stanley.  How long Saudi Arabia can put up with oil below $70 a barrel, however, is an open question.  The desert kingdom has spent billions on defense, largely with U.S. material, in the last 5 years.  According to RBC Capital Markets analyst Helima Croft, whose calculations were presented on BusinessInsider.com, if prices persist at around $75/barrel, Saudi Arabia’s government reserves could be depleted by 2018.

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