by Euan Mearns

As the oil price war unfolds it becomes easier to understand the outcome. There is ongoing speculation about the motives of the main players. Is it a battle between OPEC and US shale? Or a battle by the USA and Saudi Arabia  against Russia and Iran? I lean quite strongly towards a market driven version of the former and believe that OPEC (i.e. Saudi Arabia) cannot win against the USA. Low oil prices are a major benefit to the US economy and US citizens, a disaster for OPEC and Saudi Arabia. Figure 1 shows how halving oil prices slashes export revenues for the exporting countries while halving the cost of oil imports to the USA.

Figure 1 Oil export and import figures based on BP 2014 for the year 2013. Values based on constant $2014. The average oil price in 2014 was $110, shown in blue. Had the oil price been $50 in that year, the value of oil exports to the exporting countries would have halved (red). On the other hand, the cost of oil imports to the USA would also have halved. One man’s poison is another man’s candy.

Methodology

The methodology employed is very simple and some may argue too simple, but it serves to demonstrate a few points. I have used BP oil production and consumption data, average annual oil price data and World Bank GDP data, all for 2013 to calculate the value of production, exports / imports compared with GDP. Exports are simply the difference between production and consumption. I’m aware of the limitations here.

Figure 2 shows the value of oil production to the various economies expressed as % of GDP.

Figure 2 The oil price averaged $110 in 2013. The value of production, therefore, is barrels per day * 365 * 110. For Saudi Arabia 11.393 Mbpd * 365 * 110 = $457 billion. with GDP reported as $748 billion, oil production works out as 61% of GDP.

Consequences

The main point I want to make is that oil production is 2.4% of US GDP. The US has the biggest oil industry in the world and yet it has rather small importance to the economy as a whole. The fall in the value of oil production to $50 may turn out to be catastrophic for some OPEC countries, it barely affects USA GDP at all and bestows major benefits via lower energy costs and a positive impact on the trade balance. The gigantic size of the US economy compared with the other players is shown in Figure 3.

Figure 3 In green is actual GDP when oil was $110 / bbl. In blue is a notional GDP if oil had been $50 / bbl. Its difficult to see what is going on with the OPEC states, so they are reproduced separately in Figure 4.

Figure 4 The same data as shown in Figure 3, but for OPEC countries only. The drop from $110 to $50 is particularly painful for the Gulf States. While they may be the most wealthy, they are also being hit the hardest. Kuwait with a possible 39% drop in GDP, Saudi Arabia 33%. These numbers could be quite far out but indicate the scale of the consequences (Figure 5).

Figure 5 Had oil traded at $50 in 2013, this chart illustrates the drop in GDP that oil exporting countries may have experienced. 

To Sum Up

Cheap oil is a major benefit to the US economy. Cheap oil reduces the cost of US oil imports and is good for the trade balance. The lost value of indigenous oil production in the US is of little consequence to its gigantic economy. In summary, cheap oil is really, really good for America and Americans.

In contrast, oil production is the major part of OPEC GDP, especially the Gulf states that have rather undiversified economies. The drop to $50 is a disaster for them. With WTI flirting with near term lows (on $40.73), the time of reckoning is nigh for the oil price. Things could be about to become a lot worse. It is very difficult to understand the OPEC strategy unless there is in fact a hidden political agenda. A production cut of 2 Mbpd (shared with Russia) would see the price and all their economies bounce. Sticking to the current course will see 2016 worse than 2015 for oil producers while the consumers party.

Heads the USA wins. Tails Saudi Arabia loses.

Article link: http://euanmearns.com/opec-cant-win/

Republished with permission.

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Replies to This Discussion

Jay,

I've said that from the beginning. Skip, does not agree.

 If the political climate (as in newly elected officials) changes in 2017 (and I certainly hope it does) can't new president/congress put an import tariff on foreign oil to benefit domestic producers until oil and gas markets stabilize? When one drives through the oil and gas producing states, one see rigs and their accessories stacked up in tall grass. Those stacked rigs reflect thousands of high paying jobs that have been lost in this economy. Not only are major oil and gas companies hurting, but feeder companies that fed off the oil and gas including restaurants are closed. Anyone care to comment?? Ideas ?

Mr Mearns errs in his analysis because he portrays OPEC as a monolithic entity.  The fact that OPEC members have differing economic situations, constraints and goals and fight among themselves as opposed to acting in concert is beyond the obvious.  SA will maintain their market share at all costs.  And can likely do so for some years to come.  Domestic US production will not be impacted long term.  The reserves are not going away. The only difference will be the name of the companies producing the reserves in the future.

And who is getting the royalty income.

Russia is undercutting OPEC prices to the bone (Bloomberg).

And Saudi Arabia is undercutting Russia in Scandinavia.  The price war is global.  The LNG war starts next year with Asia being the primary battleground.

Opec isn't the only game in town any more.

Found this old 2009 oil vs gas price chart yesterday, may interest some with the coming LNG fad.
 

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