Q&A: Reasons for the Sudden Decrease in Oil Prices

Question:

Media outlets have published this Wednesday, 07/01/2015 CE that Brent Crude Oil prices hit $49.66 per barrel, as too did the American crude oil, falling to around $47 per barrel, given that oil prices in 2014 have reached $115 a barrel at the beginning of summer in June in 2014. Then returned to gradually decrease until it reached at the beginning of winter, (at the end of December 2014) to $60 a barrel, and even lower than that, when the prices of West Texas crude oil reached $58.53, and here in the first week of January 2015, it reached to about $50, i.e. more than 50% decrease within five months! What are the causes for this sudden fall in oil prices? And what is expected for oil prices in the future?

Answer:

The drop in oil prices encompasses different causes, most notably is the economic factor isolated from the political objectives … including the political factor that triggers the economic factor towards the advantage of the political factor beneficiary.

The economic factor isolated from the political objectives: (increasing the supply of oil, or lack of demand …), (Tensions, especially military escalations in the oil producing areas and around …), (speculation in the oil market and tampering with the data of weakness of the economies of the influential countries in exporting or importing of oil.)

The political factor to trigger economic factor towards the interests of the state carrying out the political action, such as (increasing the production, or supplying large amounts of oil reserves, but not for an economic need), but it is (to reduce the price in order to influence the policy of the competing states, especially those who depend in the budget on oil prices), or (to limit the production of oil shale to reduce natural oil price to the level that will bring down the cost of oil shale so that its extraction becomes irrelevant)

We will outline these issues and summarize the possible causes for the notable drop in oil prices:

First: the isolated economic factor from the political objectives

1. Supply and demand:

Oil, like any other commodity, its price is determined through supply and demand, when the oil market witnesses a surplus in supply, its price will be reduced. This is found in the economic crises of the importing countries which decreases the demand because the country in crises ability to import oil in high price is less, this is why the demand decreases which leads to the drop… Similarly when there is a great oil demand and it exceeds the supply, the price rises.

2. Tensions and Military Escalation:

There is also another factor that affects the price of oil, that is “suspense”, i.e., the oil market expectation, like the occurrence of a problem that disrupts the supply as a result of wars or tensions in the oil producing areas … Therefore, the geopolitical tensions in the Middle East where oil areas could be the cause of the rise in oil price. Although there is no change in the amount of oil supply or demand, the oil market can push towards a rise in oil prices if there are fears of a possible supply disruption. When tensions calm, there is a reduced in the price of oil back to the previous value or the real price. For example, the war-speech between the Jewish state, the United States and Iran in February 2012 CE, led to the rise in oil prices, and Forbes Magazine reported, “With the rise in oil prices reaching the highest reported levels for several years, much of it is caused by geopolitical concerns, by putting Iran on the military conflict table. Attacking Iran will push the United States into a recession,” [Forbes, February 2012].

3. Speculation and Exploitation of Economic Data:

The poor economic data of some countries that influence the oil, exporting or importing, such as the United States and China can lead to a fall in oil prices, regardless of the change in supply or demand for it. And in this case, the market fears a slowdown in economic output, and interpret it as an inevitable decline in oil consumption, and therefore the price will drop. Speculators prey on the market expectations to raise oil prices or reduce it to earn profits, and as a result, the price of oil is affected by supply and demand.

Economic data and speculation depend on a number of key players, from oil-producing countries (such as Russia, Canada, and Saudi Arabia … and others), and oil-importing countries (such as China, Japan … and others), and multi-national oil companies (such as Exxon Mobil, BP … and others), and the oil cartel (such as OPEC, and oil traders known as speculators). Each group of them have the ability to influence oil prices, either through influence on the supply or demand, or by anticipating variation in oil prices through speculation. Economic Data and speculation as a result of economic crises in relevant countries strongly affect the prices.

Second: The political factor to trigger the economic factor for the interest of political factor beneficiary:

1. The issue of oil shale:

America surpassed both Saudi Arabia and Russia as the largest oil producer in the world, because of extracting oil through jackhammers underground. Bank of America stated in the summer of 2014: “The United States will remain the largest oil producer in the world this year, having surpassed Saudi Arabia and Russia in the extraction of energy from oil shale, which would revive the economy in the country. The US production of crude oil, along with the liquid, separated from the natural gas, has surpassed other countries this year, with a daily production of more than 11 million barrels in the first quarter of this year …” “The United States is perceived as the largest oil producer after bypassed Saudi Arabia, [Bloomberg, July 4, 2014]

Oil and gas shale revolution in the United States has resulted in an increase in oil production of 5.5 million barrels per day in 2011 to what is now more than 10 million barrels per day, making it meet most of its needs, dropping its imported oil from Saudi Arabia to less than half, to about 878 thousand barrels a day after it was 1.32 million barrels per day.

But the problem with oil shale is that it has a high cost of up to $75 a barrel while the cost of natural oil does not exceed $7 a barrel, and this means that the oil-producing countries of rock, headed by the United States will be harshly hit if the price of oil dropped from the cost…

2. The subject of the reduction in price not for an economic need, but as part of the penalty for the competing states:

There are two international issues of influence and interest in the world:

The subject of Iran’s nuclear negotiations and the issue of the occupation of Russia to the Crimea, and these two countries depend in a large part of their budgets on oil exports, and the sudden drop in the oil price to half will undoubtedly affect their policies towards the two issues cited. The Russian budget contributes to the oil and gas, i.e. energy, within the limits 50%, but that is raised in some estimates, Russia needs oil prices at $105 a barrel to reach parity in the economy.

Oil contributes more than that in Iran’s budget … it reaches more than 80% of the budget, which believes that the price of oil should go up more than $130 a barrel to cover the internal projects and its assistance to its followers in the region. Therefore, the drop in the price of oil to this level strongly affects the budget.

Third: By reviewing of the above-mentioned reasons, it shows the following:

1. The isolated economic factor from the political objectives:

a. Supply and demand almost have not changed in recent years and only changes slightly and does not lead to this sudden drop, even last summer, the global price of oil has remained relatively stable at around $ 106 per barrel of WTI, for nearly four years, but a significant drop in the prices of oil cannot be explained entirely economically. Oil production has been above 80 million barrels per day over the past decade since 2004. At the end of 2013 the global oil market produced 86.6 million barrels a day, then production increased thereafter and increased demand at the end of 2013 through the third quarter of 2014, bringing the supply and demand closer together. According to the figures provided by the International Energy Agency in the third quarter of 2014, the average supply reached 93.74 million barrels, and the average demand was 93.08 million barrels [Source: International Energy Agency site]. It is a slight increase over four years that may be affected by the gradual drop by a few dollars a barrel, but it cannot fall in five months to half unless the economic factor is not the main reason.

b. Tensions and military escalation, is not new but are almost constant over the last four years … the crises in the region did not intensify sharply to cause a sudden drop in oil prices, escalation and tensions in the region since 2011 until now continue in a pace hardly surprising in events.

This is with the knowledge that in origin during political crises in a region and in the world there would be a rise in oil prices as what took place in several incidents since 1973. And now that the crisis in Ukraine, Syria, Iraq, and Libya, has intensified, the price per barrel is expected to increase to $120, and even to $150, according to some speculation. The drop in prices in this manner is unusual if the factors are purely economic because crises and wars affect the supply routes, and there will be a shortage in the supply resulting in an increase in the oil price and not a drop, therefore there are reasons other than the sole economic factor.

c. Speculation and Exploitation of economic data: since 2008 at the height of the economic crisis and things are at a standstill, they didn’t deteriorate but there was some improvement. Therefore it can be said that the sole isolated economic factor is not the main reason for the drop in oil prices to this low rate, which exceeded the 50% decline than it was five months ago.

2. Second: the political factor to trigger the economic factor for the interest of political factor beneficiary:

a. The issue of oil shale:

The cost of oil shale extraction is between $70 to $80 per barrel, and the use of advanced modern technologies in the extraction can lower this cost to reach $50-60 a barrel, the IHS company (a research company) believes that the cost of producing an oil barrel from shale oil has fallen from $70 a barrel to $57 in the last year, due to the oil men learning to dig wells faster and extract more oil, [“The Senate versus shale oil,” The Economist 6/12/2014]. Therefore, the reduction of the oil price to about $50 or $40 a barrel makes oil shale extraction futile, even if it was cut to $60-70 a barrel it would be not viable, because to be economically viable it requires an appropriate difference between the cost and the selling price.

Therefore OPEC’s lack of reduction in oil production or rather the lack of reduction in the oil production of Saudi Arabia could be one of the reasons … It is well known that America exploited oil shale production due to the increase in oil prices of natural oil to above $100 per barrel, therefore reducing natural oil prices makes the production of oil shale futile.

The natural oil prices can withstand reduction and remain viable because the cost does not exceed $7 per barrel while the shale oil costs up to ten times that as we mentioned earlier. Accordingly, whatever the reduction of price in the natural oil, it will remain viable, and as Saudi Oil Minister, Ali al-Nu’aimi, said, “OPEC will not reduce its production even if the price of crude oil fell in international markets to $20 a barrel” (Al Jazeera, 24/12/2014) and he explained that “the OPEC quota, as well as that of Saudi Arabia has not changed for several years, it is in the limit of thirty million barrels per day, of which about 6.9 million barrels is of Saudi production, while the production of other non-OPEC countries is increasing constantly.”

As it is well known, the Saudi monarchy currently under King Abdullah has strong ties with the British, and therefore we can say that the interest of Saudi Arabia not to reduce production and pressurize OPEC for this is within the British policy agreed with Saudi Arabia to influence America’s production of shale oil.

b. When America learned this is OPEC’s direction which is influenced by- Saudi Arabia, who has the greatest share in OPEC, and especially after the Organization of Petroleum Exporting Countries (OPEC) had met at its headquarters in Vienna, on 27/11/2014, and the members of the organization did not agree to cut production to support prices. This is because Saudi Arabia has refused to reduce production, and they stated that they can live with lower prices in the short term, when America learned that, Kerry, the US Secretary of State, visited Saudi Arabia on 09/11/2014 he visited King Abdullah of Saudi Arabia at his summer residence in an unplanned visit. Although the media reported reasons other than oil for the visit, but the evidence indicates that the purpose of the visit was the oil prices … After this particular visit, Saudi Arabia have begun to increase oil production by more than 100,000 barrels per day during the remainder of September and in the first week of November, Saudi Arabia has reduced the price of oil (Arab Light) by 45 cents a barrel, pushing oil prices to the rapid drop from $80 a barrel. A senior official in the U.S. Department of State that global oil supplies were discussed during the meeting.

And when he could not persuade Saudi Arabia to reduce production, he discussed the topic from another angle; he expressed approval of the reduction because it will affect Russia which occupied the Crimea as well as it will impact Iran in terms of nuclear talks, and that he sees that these reasons will find the approval from Saudi Arabia, but he wanted the reduction in the range of (80). It seems that Saudi Arabia had agreed to it or showed approval. The British newspaper, The Times, on 16/10/2014 stated that “Saudi Arabia has taken a carefully calculated position to support lower oil prices around $80 to make oil shale extraction economically non-viable, which pushes America back to import oil from Saudi Arabia and to take shale gas out of the market.” This is as a result of Britain standing behind Saudi Arabia in the face of America in its support, which is working to revitalize its economy to get rid of the repercussions of the financial crisis, even at the expense of others and striking them. It is well known that the current regime of Abdullah Al-Saud is loyal to Britain.

America showed that it has satisfied Saudi Arabia, in terms of the approval of the reduction, as well as it showed Europe that its accusation of America that it is not placing pressure on Russia for the occupation of the Crimea, and its lack of pressure on Iran in the nuclear energy file, is not true and the evidence is its agreement to reduce the price of oil which impacts the budgets of the two states … Then it also pleased some Russian opposition; in early March, the billionaire, George Soros, suggested to the US administration a means to punish Russia for the annexation of the Crimea by slashing off the oil prices … So Kerry tried to show his approval of the reduction but to a certain extent and then deceived Europe and the Russian opposition that he is serious in supporting Ukraine against the Russians, which is contrary to the reality.

But for the first time America finds itself unsuccessful, the wind came with what the ships detest, oil prices continued to fall to around $60 a barrel in few months, and Saudi Arabia insisted not to cut but it increased production, all of that resulted in a backlash in the oil market as it is known that the morale factor can influence market prices.

Fourth: Current Expectations:

1. It is difficult to reinstate the original prices.

2. However, the continued reduction affects both parties:

a. In Saudi Arabia, backed by Europe, particularly Britain, because this year’s budget is hit by deficit of 145 billion Saudi riyals out of 860 billion riyals, reserved for the expenses i.e. a deficit of about $ 40 billion, due to the drop in the oil price. And this affects its interior projects, more importantly, what occurs to Britain’s exports to Saudi Arabia, and in particular the arms due to Saudi Arabia’s budget deficit, which hit … Where Britain’s exports to Saudi Arabia amounted in 2012 to 7.5 billion sterling pounds in addition to the investments of the British companies that amount to 200 companies with investments of about $11.5 billion sterling pounds per year, all of which will be affected by Saudi Arabia’s lower financial ability due to low oil prices, and particularly that the Saudi government’s budget receives 89% of its revenue from oil exports. Therefore the continuation in the reduction will affect it in this regard.

b. On the other hand, the continued reduction affects America’s production of oil shale, because it is due to rising prices of oil in recent years it decided to invest billions of dollars in oil shale extraction in America, and it seemed so profitable, so it added over 4 million barrels of oil per day since 2008 and this is a proportion is effective in world oil production.

Although the drop in the price of oil stimulates the economy in America, but the loss of its oil shale trade is much higher, and it is not easy for it to let Europe, Saudi Arabia, and OPEC destroy its investments.

3. Accordingly either America work on modern technology methods to reduce the cost of shale oil production so that it becomes viable with the current low oil prices, and this is not easy, especially if the price of oil continues to drop, and it seems that this drop has not yet stopped. On 7/1/2015 it was published that it dropped below $50 a barrel … and either America heads directly to Saudi Arabia and creates some crisis to Saudi Arabia and make its budget deficit grows and force it to reduce production and thus increase the price of oil … and either to alleviate its crisis with Britain in Yemen and Libya in return for Britain putting pressure on Saudi Arabia to reduce production followed by OPEC reducing its production pushing the oil price to rise … Since these three need scheming but plotting… Hence, the low oil price crisis will remain the place of conflict, its drop or rise will be according to the result of the power struggle or according to compromising transactions, the capitalist way…

Fifth: the international politics is turbulent and is stumbling, as soon as a crisis ends another one starts, all of this is due to the corruption of the capitalist system that is dominating the world, which carries within it the international crisis, and then leaves people in particular suffering in miserable existence, and the international system in general … All this corruption and corrupting, misery, and suffering will continue as long as the capitalist system is in control, these crisis will not end only through a divine system that Allah سبحانه وتعالى has obliged on His slaves, it is the guided Khilafah system that carries justice and reassurance for all.

وَيَقُولُونَ مَتَى هُوَ قُلْ عَسَى أَنْ يَكُونَ قَرِيبًا

“”When is that?” Say, “Perhaps it will be soon”

(Al-Isra: 51)

16 Rabi’ I 1436 AH
7/1/2015 CE