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RUCHAN KAYA MESUT HAKKI CASIN

146146 147 CASPIAN REPORT, SPRING 2015 SPRING REPORT, CASPIAN

GLOBAL DYNAMICS OF OIL PRICE FLUCTUATIONS

RUCHAN KAYA SENIOR RESARCH FELLOW, ENERGY AND INTERNATIONAL RELATIONS EXPERT, HASEN The crude oil saw the lowest price levels since 2009 and has a few economic and political reasons behind the drop. The dramatic increase in the supply side is one of the main factors.

Within the past year or so, only one around $55-60 levels and are cur- thing is certain about the oil prices rently hovering around $65. Look- and that is the uncertainty of the fu- ing at these numbers and future es- ture price levels. In June 2014, the timates, clearly, we cannot predict end of the year price predictions of the price of oil perfectly, but we can Barclay’s was $109 per . How- identify the reasons of current trend ever, by that time, in January, the of decline, therefore lowering the

MESUT HAKKI CASIN price was around $50 per barrel. amount of uncertainty in future esti- In early 2015 and mations and policy behavior. 146 147 Bank of America Merrill Lynch made

even more worrisome price esti- 2015 SPRING REPORT, CASPIAN mates down around $35-45 range is that it is important to be aware of Onethe fact of the that first history things of oilto alreadyrecognize in- early March, the oil prices oscillated cludes such price booms and busts. in their Q1 projections. However, in Figure 1. Crude Oil Prices in 1861-2013 ($)

Source: BP Statistical Review of World Energy, 2014 As Figure 1 shows, recent low prices than doubled the crude oil price, ris- of oil are nothing new as sharp de- ing from $14 per barrel to over $30 clines have existed in the past. Al- levels. Figure 3 displays world oil though the crude oil price has been supply as well as the variation in re- increasing historically since 1860s, gional production levels and shows looking at the adjusted prices with the decline in production from 66 2013 dollar values, similar price million in 1979 to 56.6 million bar- booms and busts appear to have hap- rels per day in 1983. pened in the past. Although the prices have soared The most recent sharp price decline immensely following these two in- occurred in 2009. Another one was ternational supply crises of the 70s, in the 1980s, after historically high over the course of a year, the oil levels in 1970s due to two major prices once again have decreased supply crises. The supply crises that from $27 per barrel in 1985 to $14 increased the oil prices in the 70s in 1986. The levels of $27 per bar- rel did not reach to the same levels Israeli War and , until the . As Figure 1 displays, were due to regional conflicts, Arab- $27 at the time of the Iranian Revo- because of an OPEC embargo which lution was almost equivalent to the respectively. The first crisis emerged quadrupled the price of oil from $3 astronomic levels following the Iraqi to $12 per barrel in about six months, war. The main reason for such price

RUCHAN KAYA starting late 1973 and ending in decline in the 80s was oversupply early 1974. The second crisis was in the which attracted non- 148 also a supply crisis due to the Iranian OPEC producers to increase their Revolution in 1979. Figure 2 demon- production. As Figure 3 shows, non- strates the decline in supply levels. OPEC production was around 19 mil- The Iranian production fell from 5.3 lion barrels in 1972 and reached up million barrels per day in 1978 to to 25 million in 1980. In terms of the 1.5 and 1.3 barrels per day in 1980 market share, non-OPEC production and 1981, respectively. This sharp was 36 percent in 1972 and reached decline in production levels more up to 51 percent in 1985.

Figure 2. Oil Production in

Source: BP Statistical Review of World Energy, 2014 Figure3. World Oil Supply by Regions and Groups (barrels per day)

Source: BP Statistical Review of World Energy, 2014

POTENTIAL REASONS BEHIND decreased again especially among THE FALL OF OIL PRICES the developing countries. Within the BRICS countries, which usually drive The crude oil saw the lowest price the energy demand, the economic levels since 2009 and has a few eco- growth rate has slowed down after nomic and political reasons behind 2010 and in turn the oil demand has 149 the drop. The dramatic increase in experienced a decline as well. CASPIAN REPORT, SPIRING 2015 SPIRING REPORT, CASPIAN the supply side is one of the main factors. While already qua- Although the price decline has been drupled its production levels after hurting the revenues of the produc- the sharp decline during the Arab ers, there are a few reasons behind Spring, increased its production their refusal to cut back production, with new investments. Beyond these especially driven by two countries, by improving shale - oil production, the US increased its tion of these countries is not to lose and the Gulf states. The official posi production capacity from 6.8 million their market share to rising Iraqi and barrels to above 10 million barrels Iranian production. Among these per day while more than doubling countries, especially Saudi Arabia is unwilling to cut back production. In total, world production of oil has has been consistently increasing the domesticincreased rig from count 81.3 within million five to years. 86.2 However,production according levels since to BP 1985, figures, rising it million barrels per day from 2009 to from 3.6 million to just below 11.5 1 2013. While global oil supply has million barrels per day in 2013. In increased in the past few years, eco- terms of the share of the market, nomic growth has plummeted. After Saudi Arabia accounted for 6 per- picking up with growth following the cent of the world oil production in negative effects of the 2008 global 1985 and increased its share since then, currently accounting for 13 financial1. “BP Statistical crisis, Review growth of World Energyrates 2014.have percent of the world supply. There- bcm export in 2013. Oil and natural fore, the claim that the country does gas revenues also account for more not want to lose its market share is than half of the Russian state budget. rather unwarranted; rather, pushing Therefore, relying on such natural for more market share seems like a resources as primary source of in- better description. Another economy based claim, attempting to bankrupt loss due to the Western sanctions producers with higher break even overcome Crimea –not to annexation- mention the will financial exacer- costs is a more plausible explanation. bate the consequences of the falling The Saudis have very low production oil prices on Russian economy. costs ($4-5 per barrel) compared to their competitors in North Amer- North America ica. Furthermore, having Sovereign Wealth Funds over $800 billion, the Although the is one country has the luxury to sustain of the largest oil producers in the lower crude prices despite losing world, unlike , it is also one of substantial export revenues. the major winners of low oil prices, especially on the political side of the THE CONSEQUENCES OF LOWER spectrum. Domestically the consum- PRICES ers enjoy lower gasoline prices. EIA estimates an additional $750 sav- Russia ings per household due to cheap gas while families which use heating oil RUCHAN KAYA Being a major oil producer in the may enjoy another $750 advantage world, Russia is also one of the main over the year of 2015. This is a major 150 losers of the current oil price bust. boost for lower and middle income - families and a major political ad- mated a loss of around $100 billion vantage for the current administra- The Russian finance minister esti a year when oil prices were around tion. Internationally too, US is able $76 at the end of November last to hurt its global adversaries like year. Since then the prices kept go- Russia, Iran, and through ing down further and currently for lower prices. A similar strategy was 2015, IEA expects the oil price to followed in the 1980s where Saudi range around $55 per barrel. With Arabia started to increase its oil sup- ply dramatically, helping to lower the loss from the oil prices could go up to price of oil in order to hurt Iran-- and $183such estimatesbillion for the 2015 Russian due to financial the de- also the Soviet Union. At the time cline in oil prices. Furthermore, Gaz- these pricing policies of the Kingdom prom’s natural gas contracts are tied received criticism from bin Laden to oil prices, mostly with a six-month who wrote a letter to King Fahd and lag.2 Because of these agreements accused him for serving American and Russia will experi- interests and consumers while hurt- ence the negative effects of the price ing the Saudi economy.3 shocks with a six month delay. Rus- sia is one of the largest oil producers in the world with a capacity of 10.8 Unlike the United States, its north- million barrels per day and the larg- ern neighbor, Canada appears to est natural gas exporter with 225 struggle as the price of oil plummets.

2. “Kramer 2015. http://www.nytimes.com/2015/02/28/world/europe/russia-and-ukraine-calm-feud- over-natural-gas-payments.html?emc=edit_tnt_20150227&nlid=61706155&tntemail0=y&_r=0 3. Gamal and Jaffe p. 66. With high oil prices and the avail- ability of new technology, Canada invested over $150 billion in oil in- dustry and now struggling due to low oil prices. The Canadian central bank lowered the interest rates and the currency depreciated close to 20 percent. Given the current situation, the already unpopular conservatives might lose the federal elections after 9 years in the upcoming elections in October 2015 if the price of oil stays this low.

Looking Ahead

It is hard to predict the direction of the volatility in oil prices. Even the major players in the markets fail to make healthy short or long term predictions. However, taking les- sons from the history might help us better understand the political and economic dynamics behind such 151

the major price declines in the past, 2015 SPIRING REPORT, CASPIAN Figuredrastic 1price displayed fluctuations. how similar Looking ups at and downs have happened in the

had different dynamics like supply crises,past. However, oversupply, these major fluctuations political disagreements or wars. The current price decline seems to be a product of oil glut which is similar to what happened in the 80s. The question is whether major oil producers will

and force to bankrupt small drilling companiescontinue to or fight agree for to market cut back share the supply in the short term. For now the latter appears to be a far-fetched idea. Another possibility is a poten- tial increase in oil demand through

growing BRICS economies. a financially healthy Eurozone and