Geopolitics of oil: Saudi oil Minister Ali al-Naimi gloomy about the impact of collapsing oil prices (top); President Joko Widodo plans to use the windfall to upgrade Indonesia’s creaking infrastructure
NEW HAVEN: Oil shocks four decades ago transformed the world economy and geopolitical landscape, and the latest oil crisis threatens to do the same. The price of oil hovered near $100 per barrel during the past three years, and the recent vertiginous fall in price to near $50 per barrel has sent markets reeling. Ali al-Naimi, oil minister of Saudi Arabia, considered the industry’s most powerful decision maker, said oil could fall to $20 a barrel.
While oil-consuming nations celebrate, the exporting nations anticipate unprecedented economic and political challenges. Most countries are importers of oil, so they will benefit from lower prices.
Lower prices improve economic prospects by way of two main mechanisms:
The first is through better public finances. In many developing countries, governments heavily subsidize energy usage by selling fuel for automobiles far below the market price. These policies have been destructive on many levels. By reducing fuel prices, such subsidies discourage fuel efficiency, exacerbating global warming. And they impose a dangerous burden on public finances because governments are on the hook when oil prices increase. Though fuel subsidies are often rhetorically justified on the grounds that they help the poor, research suggests that in most countries the middle class receives the bulk of benefits.
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Some developing countries have taken advantage of lower prices to cut or eliminate fuel subsidies. When prices are high, scrapping subsidies shifts costs to consumers and risks political backlash. Now, however, extremely lower oil prices provide political cover to undertake tough reforms. Indonesian President Joko Widodo, for example, is developing a plan to sharply cut fuel subsidies and redirect public spending to more productive uses, such as infrastructure or education. If more countries follow Indonesia, the policy changes facilitated by lower oil prices will underwrite more economic growth for years to come.
The second mechanism by which oil consumers benefit from lower prices is straightforward – households have more money to spend on other goods. In the United States, for example, consumers spent $370 billion on gasoline in 2013, according to analysis from Goldman Sachs. That constitutes roughly 3 percent of total household spending. Lower prices may save American consumers $125 billion over the coming year. Chinese consumers are less avid drivers than Americans, but they too will notice the economic effects as energy costs influence the price of food – Chinese spend near 27 percent of their income on food while Americans spend about 6.5 percent. Indeed, across the world, consumers will experience similar windfalls if oil prices stay low. In economic terms, this will function as a medium-size tax cut and boost consumption as people can afford to buy more goods or save.
Both the short and long-term effects of lower oil prices bode well for the global economy. But there are downsides, too, including threats for Japan and the European Union. Japan has suffered from years of falling prices and low inflation, and the governor of the Bank of Japan, Haruhiko Kuroda, has declared a goal of returning Japan to “normal” levels of inflation, meaning an increase in prices each year of at least 2 percent.
Similarly, falling prices in Southern Europe coupled with stagnation in Germany threaten to pull the entire eurozone into sustained deflation, thus dragging down regional economic growth yet further. For both Japan and the EU, lower oil prices complicate monetary policymaking as central bankers currently look for higher, not lower prices.
Japan has already embarked on one of history’s largest programs of so-called “quantitative easing,” by which the central bank increases the money supply in order to spark gross domestic product growth and higher prices. Many economists have urged the EU to do the same, but complicated politics – and Germans’ aversion to active monetary policy – restrict Europe’s ability to enact an expansive monetary policy.
Reversal of fortune: Abrupt drop in oil prices transforms economies of oil exporters when more than half of budgets rely on revenues from energy sales (Sources: Wall Street Journal; Ycharts andNasdaq; Tax Policy Center)
Although lower oil prices will likely help repair family budgets, central bankers in Europe and Japan are wary that falling oil prices will lead consumers to expect falling prices in the future. Consumers’ expectations about price movements have significant effects on spending habits. If they expect lower prices in the future, they may put off purchases, threatening overall reductions in consumer spending and economic growth.
The biggest losers from lower oil prices, however, are countries that depend on energy exports. Many of the Gulf exporters, such as Saudi Arabia and Kuwait, are rich enough to survive a period of low prices with only a bit of belt-tightening, though even Saudi Arabia posted a budget deficit this year. If oil prices stay low for a period of years, the Saudi social contract may face a wrenching revision. That is a long-term prospect, but other countries, like Iran, Venezuela and Russia are suffering immediate financial crises as reduced oil-export revenue wrecks government budgets and sends those economies into a tailspin.
For example, Iran, one of the world’s largest oil exporters, is losing an estimated $1 billion per month because of reduced export revenue. Indeed, some analysts, such as David Gardner of the Financial Times, have speculated that Saudi Arabia’s willingness to tolerate low prices is a geopolitical move designed to place pressure on Iran to cut a deal over its nuclear program.
There is little evidence so far that the oil-price collapse has tempered Iran’s geopolitical ambitions. By contrast, Vladimir Putin’s Russia has seen a dramatic reversal of fortune over the past six months. This summer, Putin was riding high after managing to annex Crimea and set up rump states inside of Ukraine without provoking anything more serious than economic sanctions.
The oil-price crash has changed that. Because Russia’s economy is dependent on hydrocarbon exports for two-thirds of its export revenues, lower prices have led the ruble to collapse vis-à-vis the euro and dollar. That has created sharp problems for the Russian economy, since many large firms have debts denominated in foreign currency which they will struggle to repay.
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Russia’s economic problems are forcing the country’s elite to reconsider its geopolitical position. Earlier this year, many in Moscow speculated that Russia had the resources to survive a serious deterioration in ties with the West, and to sell gas to China instead. With plummeting oil prices, however, many in Russia’s elite now realize that their country’s main export – energy – is far less scarce than it used to be. Oil is a much less influential geopolitical tool. As a result, some Kremlin advisors have urged Putin to improve relations with the West.
Indeed, as oil prices slide, the Kremlin adopted a more conciliatory policy toward Ukraine in order to regain confidence of financial markets and stabilize its economic position. Russia appears to have abandoned efforts to set up independent statelets in Eastern Ukraine, and fighting in the region has fallen sharply since early December.
Similarly, petroleum products constitute almost all Venezuelan exports, so lower oil prices put serious pressure on the country’s budget and current account. Inflation has spiked, and shortages are already widespread, so the crisis places further pressure on Caracas to cut subsidized oil shipments to likeminded Latin American states and adopt a less costly foreign policy.
The effects of lower oil portend big changes – so long as energy prices don’t rise again soon. Across the world, the new energy landscape portends sharp and controversial changes, from public finances to monetary policy to geopolitics. Oil exporters have grown used to throwing around their weight and their petrodollars to get their way, from Saudi Arabia’s network of extremist madrassas to Russia’s support for warlords across the former Soviet space. If oil prices stay low, countries will find that shrinking budgets no longer support grand geopolitical ambitions.
By Chris Miller
Source - http://yaleglobal.yale.edu/
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There is also a geopolitical benefit in that the US might have to flex its military muscles less if oil producing countries have less money to support proxy wars or in the very least petro dollars are more likely to flow to say food for their people instead of funneling or trickling down to terrorists.
Another indirect benefit is that not only will consumers pay less for getting from point A to point B, but a large factor in costs for goods purchased is transportation. With most if not all consumer goods being transported in one way or another by truck, it leaves room for those goods to come down in price as the cost of bringing them to market have come down as well. Already, I have personally witnessed the price of bread coming down to below a dollar a loaf in my local supermarket.
Finally, as substitutes for oil such as ethanol ( currently made mostly from corn ) become less economically viable because it seems less likely to substitute ethanol for petroleum when oil prices are low, a multiplying effect takes hold from less demand for corn and lower prices for animal feed ultimately leading to reduced food costs as well.
A major concern from this is that consumers may see a deflationary time period and start putting off purchases as tomorrow will bring a lower market price for the goods they buy. Also as the value of the dollar inherently goes up in that more goods can be purchased with fewer dollars, US manufacturing may suffer against foreign goods produced with say Euros or Chinese Yuan or Japanese Yen.
The flip side to that argument is that with more dollars in the hands of consumers, inflation may begin to take off as people spend spend spend their new found windfall arising from lower fuel costs. As the old proverb goes, "May you live in interesting times." The Federal Reserve must cautiously examine the conditions in the economy to maintain the stability of our economic growth.