Oil prices collapsed in 1985 after the Saudis could not continue to perform the role of swing producer, which considerably squeezed their oil productions and revenues during those years. They let things go for a while and adopted the net back pricing which within a short period caused the oil price to plunge to $10 a barrel.
In 1997, the Southeast Asian economies suffered a severe currency crisis which led to a difficult recession in those countries. Oil prices collapsed again in 1999.
Now in 2014, the European countries are on the brink of a third recession and Japan’s weak growth seems to be stuck in its place. China is also showing slow growth. In addition, there is an oil glut in the world. In the fall season there is usually a depletion in oil inventories, but this fall oil inventories are going counter-cyclically which means they are rising.
More importantly, it does not seem that OPEC was keeping abreast of what has been happening in the oil shale market over the last four years and now it is caught with its pants down. In addition to the rapid increases in oil production in the United States and that the Saudis and the Kuwaitis are now after maintaining their market shares, there is a new element on the pipeline front.
The opening of the East Siberia-Pacific Ocean pipeline from Russia to China (3,018 miles) is enabling the former country to compete with Saudi Arabia with better quality oil at a lower price. In return, by cutting its price to Asia, which usually carries a premium over the prices it charges Europe and America, Saudi Arabia hopes to directly undercut the Russian competition.
Consequently, it seems that OPEC is in disarray. This is the perfect storm for a fast plunge in oil prices that may even surprise the Saudis.
I wonder if the Saudis have a concrete oil plan in conducting their market share strategy going ahead. If one of the objectives is to slow the oil shale production in the United States like the one in the Bakken fields in North Dakota and the Marcellus fields in Pennsylvania, they have to put up with prices as low as $60 a barrel or even lower.
The Saudis have a breakeven oil budget price of about $90 a barrel. They could survive this constraint for a year or so at a price of $60 or less. But in the midst of the political turmoil in the Middle East and given the Saudi bloated government budget, can the Saudis survive a $60 a barrel for more than a year?
Shale production started in the 2008-2009 period when the United States was going through the Great Recession and the West Texas Intermediate price dropped to $30 a barrel.
There also are those on Wall Street who believe that shale production in certain areas of the United Sates can survive $28 a barrel. Can the Saudis survive that?
Moreover, the shale revolution is bringing technological advances in shale drilling, which means that shale oil prices should drop for several years before they stabilize like the prices of solar energy.
If the other objective is to hurt Iran and Russia, this will bring the Saudis more costs than benefits. The Iranians have already absorbed the U.S. sanctions and their economy has started to grow. Now they want to compete with the Saudis head-to-head in terms of increasing oil production.
If Russia is hurt, putting politics aside the hurt will transcend to international banks and European economies, which turn may affect the U.S. economy and global growth. The economic growth cycle will not end until it drops oil prices further. Standing now at $80 a barrel, some guess the next level is $70 while others go as low as $50.
What OPEC and the Saudis should do is to learn from their experiences in 1985-86 and 1998-99.
In those years the Saudis got the cooperation from their colleagues in OPEC to cut production. In 1998-1999, they received cooperation from Norway, Mexico and Russia who they are trying to hurt now. The Saudis are playing the wrong political game.
Since they stopped using oil as a political weapon, they should stop playing this game. They should learn from their successes in 1986 and 1999, rally oil-exporting countries inside and outside OPEC to stop the prices from an eventual drastic plunge. The Saudis should also stop their politics and live within their means.
Meanwhile, I and many consumers are now happy when we go to the gas station!
Shawkat Hammoudeh is a professor of economics at Drexel University. He can be contacted at op-ed@thetriangle.org.