Dear Pakistan, let America and Saudi Arabia fight over oil prices because it works in your favour!

Published: December 14, 2014

The economics of oil is seldom disassociated from global politics, but the production landscape has changed forever. PHOTO: AFP

Oil prices are way down these days. Crude oil prices have fallen by more than $50 per barrel in international markets in the last six months. From $115 in the middle of June, 2014, the price of a barrel of crude oil has fallen to $65, as of the second week of December.

On November 27, 2014, the prices took a definitive downward turn when Saudi Arabia – the largest and strongest member of the Organisation of Petroleum Exporting Countries (OPEC) – refused to mitigate production. And since none of the other OPEC nations are cutting back, there isn’t a way to eliminate the current two million barrels per day of excess supply from the market.

Without the excess supply being addressed – and with China and European economies still struggling to return to robust growth rates – there is essentially a glut of oil in the global marketplace with producers cutting prices to retain market share.

The American factor

The excess supply has resulted largely due to America making strides in oil drilling. From being the largest importer and the largest consumer of oil, the United States has also steadily become the largest producer of oil.

Yes, you read that right.

The US was the largest producer of oil – generating more than 12 million barrels per day – in 2014. That is an average daily volume ahead of Saudi Arabia and Russia. Americans have been extracting oil from shale rock using hydraulic fracturing or ‘fracking’.

Photo: US Energy Information Agency (EIA)

Photo: US Energy Information Agency (EIA)

The oil interests of Saudi Arabia and United States are currently at odds. Saudi Arabia is calculating that sustained lower oil prices below $70 will discourage American oil producers from drilling more wells, since shale rock is only viable when international crude oil prices remain above $70 per barrel. Saudi Arabia loathes the idea of giving up its US-based customers to domestic producers. So, for Saudi producers, to increase prices through OPEC by cutting supply would end up playing into the hands of its US competitors.

A boon for Pakistan

Let’s be unequivocal about this: Falling oil prices are typically good for consumers and their household budgets the world over. The less you spend at the pump, the more you have available as a household to spend on other consumables.

It’s almost like a free stimulus to the economy, allowing funds to flow towards consumer spending by families instead of wealth creation by oil interests. Consumer spending, of course, generates a virtuous cycle of spending within an economy, whereas oil interests only end up hoarding those extra profits.

According to the Organisation for Economic Cooperation and Development (OECD), a $20 drop in price adds 0.4 percentage point to growth in global economy. With a $50 drop since June this year, we can expect a full percentage point increase in global GDP next year, if the current oil prices sustain.

Here are some key benefits that Pakistan should expect from the falling oil prices:

Reduced cost to farmers

Countries like Pakistan, India or Bangladesh, that rely on agriculture stand to gain the most from the on-going oil price war between OPEC and the US. Farmlands tend to be even more energy intensive than manufacturing. According to the World Bank, a dollar’s worth of farm production could take up to five times more energy to generate than a dollar’s worth of manufactured goods. So the cost of farm production in Pakistan should go down as well with the oil prices.

Reduced import bill

At current price levels, Pakistan alone could save more than $5 billion over the next year in oil imports – a much-needed boost to its foreign exchange reserves. In 2014, Pakistan paid an average of $108 for about half a million barrels a day that it consumed during the fiscal year. Contrast that with an average price of $65 for crude oil in fiscal year 2015 and the savings could be phenomenal.

Curbing inflation

Falling oil prices should help to curb some of the rampant inflation, by not just reducing prices at petrol pumps but also by helping to keep in check the costs of manufactured goods.

Cuts both ways

Diversified economies of oil producing nations, like the US, Mexico, Norway or Canada, benefit from falling oil prices too. Although the oil-drilling sector faces price and margin pressures, their consumers on the other hand save money each day in gasoline purchases.

Not all economies will benefit from falling oil prices though. The impact of lower prices could begin to take a toll on the stability of some producer nations. Quite a few OPEC and non-OPEC nations could struggle with their budgetary commitments. Iranian budget, for example, is based on oil being at $136 per barrel. Russian budget is based on oil being at $101. Nigeria and Venezuela need oil prices at $120 to meet their fiscal commitments.

With oil currently at under $65 per barrel, those nations will have to find either alternate means to fulfil their budgetary commitments or simply have to dip into their sovereign funds.

Saudi Arabia, on the other hand, is poised to wage a price war, thanks to a $737 billion sovereign fund. It can tap into its reserves if and when needed to meet its budgetary obligation. UAE and Qatar have similar deep reserves to see this price war through.

Politics and oil mix

Interestingly, lower oil prices also place pressure on the Iranian government at a critical juncture where it is negotiating a nuclear deal with the international community. Could a sustained budgetary pressure resulting from lower oil prices make Iran more flexible to international demands?

Lower oil prices serve a double whammy for Russia as well. The country is already reeling from the economic sanctions placed on it by the international community – and the resulting flight of capital – due to its invasion of Ukrainian territory. Rouble is down 40 percent against the dollar this year. Will Russia reassess its global ambition in view of the energy scenario?

The economics of oil is seldom disassociated from global politics, but the production landscape has changed forever. With improved drilling methods, lower cost of production, and increasingly accurate exploration, the cost of oil should remain lower in the long run. Add to it the divergent interests of the three largest producers – the US, Russia and Saudi Arabia – and consumers should stand to benefit in the long run.

After years of expensive oil, falling prices are a well-deserved respite for consumers. Nothing wrong with a good old-fashioned price war between major oil interests – however long it lasts.

Nader Nanjiani

Nader Nanjiani

The writer is a Pakistani-American who lives and works in the United States. He tweets @nader_nanjiani (twitter.com/nader_nanjiani)

The views expressed by the writer and the reader comments do not necessarily reflect the views and policies of The Express Tribune.

  • Maximus Decimus Meridius

    Quite good. I liked it that you have taken politics out of it for most part and concentrated on the energy/economic scenario. Also that you have not delved into the intricacies of international oil trade and have kept the blog relatively simple so people like em can understand. I really like it when an author takes time to do his research then goes the extra mile to dumb it down for the laymen. Thank you very much and well done,Recommend

  • Parvez

    Interesting and made good sense. From a little I’ve read it’s about USD 55/ barrel and not USD 70 that would dissuade US producers of shale oil from further explorations and at that level it affects the development economies of the Gulf oil producers…….so it looks like a game of chicken and the US does not look like the one who will blink first.Recommend

  • barndoor

    “Yes, you read that right.

    The US was the largest producer of oil –
    generating more than 12 million barrels per day – in 2014. That is an
    average daily volume ahead of Saudi Arabia and Russia. Americans have
    been extracting oil from shale rock using hydraulic fracturing or
    ‘fracking’.”

    Oh no. I had no idea. It’s not like I have 24/7 access to news on the web. I have never visited CNN, BBC and other western media outlets’ websites. I don’t think anyone else in Pakistan has either. That’s why we don’t find your article at all patronizing.

    Regarding the title of this article, I’m glad the Saudis and Americans are asking for our permission before they fight over oil prices. It makes me feel really proud that these mighty nations should ask Pakistan first before they do anything.Recommend

  • BlackJack

    Incredibly churlish response to a reasonably well-written and informative blog. The titles are apparently cooked up by someone on ET, so don’t take it out on the blog writer.Recommend

  • Hard_Truth

    Clearly you have too much time on your hand that despite finding out all about the topic from other international sites you still read all of it. Especially when the title had already tipped you off that it wasn’t going to be worth much.Recommend

  • http://peddarowdy.wordpress.com/ Anoop

    In a free market economy, this will only force US Companies to cut costs, ship jobs(you know where – India) and become more robust. It will pay off in the longer term.

    I see the importance of India and China, who are the largest consumers of Oil now, rising massively. All the OPEC Countries and US will be trying to woo the giant customers. When this happens, I don’t know how Pakistan benefits. India can use its important as a consumer to get countries to back off Kashmir and even reprimand Pakistan(especially Saudi Arabia which has a huge say in Pakistan’s affairs)Recommend

  • kirmani

    Mods, give us a delete button. It will help us clean up the comments section from spam, which adds no value to a piece.Recommend

  • Hard_Truth

    You clearly have too much time on your hand that you spend time reading stuff you you know full well about from other news sites. Especially when the title of the article had tipped you off that it wasn’t to your high standards.Recommend

  • Optimus

    The argument that KSA is sticking to an oversupplied market to combat the American boom of shale gas and oil appears to be flawed. Oil at USD 60/bbl for a prolonged period (1-3yrs) appears highly unlikely. Once oil prices go up drillers in USA can go back to fracking again. It appears that this move is more to crush Russia and Iran both of which depend on USD 105/bbl to balance their budgets. And if prices hold up here for even a yr that would make increase their fiscal deficits by ~50%.Recommend

  • 2Paisa (Khi)

    Oil prices are being used to put the pressure on Iran and Russia. The silence from OPEC/SA is an evidence of that. In the long run, I think the current prices are unsustainable and the market is overly bearish. Good arbitrage opportunities for the fuel (barges/sing oil), light ends (naphtha) or distillates (gasoil) traders though…

    @Anoop, India is too small a player to have any say in the global market – USA consumes around 6 times more oil than India and China consumes around 3 times more and Japan consumes more than India too. India’s consumption is around the same as Russia, SA, South Korea, Brazil, etc.Recommend

  • Indiantroll

    why the heck would they ship oil jobs to India, oil is about geology, not some Hindu birth rite. China spends half a trillion dollars a year on energy, they have massive oil companies like CNPC, PetroChina and Sinopec even though they have relatively little oil and gas in their own country. India on the other hand, has a few tiddlers like Vedanta/Cairn and the state owned Indianoil.Recommend

  • cautious

    Good example of free economy at work and why the USA is the dominant economy on the planet. Oil prices were high and those high prices provided the incentive for private industry to spend money to find/extract oil. It wasn’t the govt or a bunch of politicians setting prices to attract votes – it was good old fashion supply/demand and private industry. Something Pakistan should take note of.Recommend

  • http://peddarowdy.wordpress.com/ Anoop

    So, are you saying Oil companies do not need infrastructure services like IT?

    Are you saying an Oil company executives talk to each other over snail mail? Or, perhaps they attach messaes to a Dove?

    How do they bridge the Supply Chain Management problem? Pen and Paper?

    How about HR Solutions? How about Inventory Management?

    Or, cheap equipment to drill Oil? Indian manufacturing is definitely more cost effective than US!

    What an uneducated, naive, ill-informed, hateful comment.

    I never said China will not benefit. I am merely suggesting India definitely will.

    The value of India as a consumer will rise immensely.

    http://en.wikipedia.org/wiki/List_of_countries_by_oil_consumption

    India is #4 and will likely be #2 in 20 years.

    When the number of suppliers increase, the value of the consumers increase manifold. Common sense, really. I don’t expect you to understand this after your idiotic rant.

    Looks like Pakistanis have started seeing China’s success as their own. China might grow, but Pakistan certainly will not.

    http://tribune.com.pk/story/181361/economic-survey-2010-11-has-the-real-poverty-rate-hit-43/Recommend

  • ovais

    There is a possibilty of pakistan having a positive or less negative trade balance for once in the last 30 years. its a good omen for pakistan but it has the potential to destroy pakistani oil industry which is booming and creating jobs. Govt needs to plan and think before they take measures. Investment in dams etc is crucial for pakistans longetivity and the new sum saved from oil import can be used for thatmRecommend

  • Gul Zaman Ghorghast

    ‘ …never visited CNN,BBC..other western media websites..’
    Has a computer, iPhone? and was able to navigate to ET
    website to leave joke,..er…comment.
    Thought he was a hindu troll, since they infest the blog section.
    Also known as ‘India Section’. Now, rest assured the moderators
    will not print this.Recommend

  • Usman Ali

    Well written, As Pakistan prospective it is very good, as already showed in your title. ThanksRecommend

  • abhi

    While George Bush is villain for many, I remember he made a policy decison to ensure US doesn’t have to import oil in future. That initiative are bringing fruits now in form of lower crude prices.Recommend

  • abhi

    I don’t think Saudi Arabia is going to have their way. The good thing about any technology is that its cost always goes down with time. Today shale is profitable only if prices are above $60 per barrel. This cost is going to be even less in future and more and more countries will be able to explore their own shale reserves. Also with the advent of alternative sources of energy the oil prices will be low for long time.Recommend