By Shane Ferro
This week’s plunging prices come after OPEC agreed not to cut oil production. In other words, they are not making an effort to relieve the oil supply glut that’s been keeping prices low.
At the moment, falling energy prices are basically a tax break for the American consumer.
Longer-term, the danger might be a huge price swing in the other direction, especially if today’s low prices force too many unprofitable producers throw in the towel in the next year or so.
There’s also the issue of civil unrest in countries that rely heavily on oil revenue.
Morgan Stanley’s Adam Longson lays out the risk of low prices (mostly super-high prices later):
Losing too much investment or stimulating demand could create a price shock in future years as necessary supply growth cannot return quickly once curtailed. If anything, removing the “OPEC put” should raise the hurdle rate required on oil projects, which may require even high prices for higher cost and risky projects. Moreover, as prices fall, outage risks rise, particularly from financially stressed nations that cannot maintain subsidies (e.g. Venezuela, Nigeria, etc.). As subsidies are lifted, the risk of civil unrest tends to rise, putting production at risk. With little spare capacity today, the market has few options to deal with a large outage.
Basically, MS is saying that the OPEC cartel has lost, or given up, its control of the market, which will inevitably lead to more volatility. Without producers being able to rely on OPEC keeping prices stable at a relatively high level, investing in infrastructure for oil production projects is going to become more risky, and therefore more expensive.
This is bad for production in places were costs are high like the US and Canada (which will ultimately lead to much higher prices in a couple of years as demand increases). It could also lead to civil unrest in places like Nigeria and Venezuela, whose economies are much more reliant on oil profits, and don’t necessarily have the cushion to keep subsidies going until prices level off.
Here’s how the freefalling price of oil is affecting Venezuela, from Linette Lopez’s post earlier this week:
In the past year the country’s inflation rate has grown to about 64%, its export basket has fallen over $30 to $68.97 (a four-year low), and currency reserves are at an all-time low. For the past month, Venezuelan bonds have been selling off at breakneck speed.
Venezuela’s foreign minister Rafael Ramirez told reporters earlier this month that the country was ready to cut oil production. The commodity makes up 95% of the Venezuela’s export revenue.
The country needs the average price of oil to sit at about $85 to pay for imports and keep up with its debt. It has been struggling with the former for some time. Household goods like toilet paper are scarce in the country, and shoppers wait in long lines for government supermarkets — even sometimes getting their arms marked with their spot in line.
So, as we enjoy the extra discretionary spending power from low enegy costs, we must remember that cheap energy isn’t free.