Oil has often been called black gold and, in 2015, the comparison is truer than ever. The main difference is that oil has intrinsic value in a way that gold does not; it literally powers the world. Since hitting its 2014 peak in June when it was trading at $115 a barrel, oil has dropped by 50% in the past six months, and seems set to go even lower. This is an unusual turn of events, considering the turmoil in Iraq, Libya and other big oil producers.
In the abstract, lower oil prices appear to be a good thing, especially for some of the world’s poorest people who rely on fuel to cook their food. There’s no doubt that high prices have been a burden shouldered by those with the fewest resources. But like so many other issues, deflation is a double-edged sword – and is complicated by the threat it poses to our highly leveraged global financial system. It may seem alarmist, but a cascading series of failures in the energy sector could make the 2008 financial meltdown look like a hiccup in comparison.
When deflation happens at this pace, even the experts are left scratching their heads. The short answer is that the world’s largest producer, Saudi Arabia, is using its vast reserves to flood the market with discounted oil and has convinced its OPEC allies to go along. The question remains, why?
Winners and Losers
Saudi officials have said that this policy is a response to lower global demand, but a quick look at some of the nations most affected by lower prices makes you question if this is the only reason. Venezuela, Russia and Iran are all dealing with destabilization as a result of the oil free-fall. This looks a lot like a list of countries that have official Washington’s ire.
Let’s look first at Venezuela, where 95% of the country’s export revenue comes from oil. The current drop in price has left the government in Caracas no choice but to slash the budget. This means that a lot of the gains alleviating poverty throughout the country in the last 15 years could be slowed or even reversed. President Nicolas Maduro lacks the charisma of his predecessor Hugo Chavez and has been embattled since the beginning of his term. Ending the Bolivarian revolution has long been a priority for Washington’s foreign policy elite, and whether Maduro can outlast the current crisis is debatable at best. But destabilizing Venezuela may finally be just a bonus – because the real targets of the arranged oil deflation are Iran and Russia.
Several sources have reported on a secret deal reached by U.S. Secretary of State John Kerry during his visit to Saudi Arabia in September, when he coordinated with Riyadh on the Syrian civil war and how to deal with ISIS. The Saudis have watched nervously as their mortal enemy Shia Iran has benefited from America’s blunder in Iraq, which brought that country into Tehran’s sphere of influence. Plunging oil prices along with international sanctions over its nuclear program will certainly test the leadership in Iran, although it may not curb their regional influence in the long term, which is based as much on cultural as economic power.
Which brings us to Russia. I’m no apologist for Vladimir Putin, whose social policies, especially regarding the country’s beleaguered LGBT community, have often been repugnant. Still, in global affairs it’s hard to argue – as so many in the Western media do – that he’s not a rational actor. He and Foreign Minister Sergey Lavrov scored a series of diplomatic victories in late 2013 and early 2014, no doubt enraging their chicken-hawk opponents at think tanks throughout the Western world. First they brought Iran to the table on the nuclear issue. Later they prevented a NATO intervention in Syria by negotiating a deal with President Bashar al-Assad to turn over his chemical weapons arsenal.
In Ukraine there has been a lot of bluster on both sides, but NATO and its media cheerleaders have to accept a fair portion of the blame for the continuing crisis in the east of the country (as well as encouraging militias made up of people who, if active politically in another country, would certainly be called Neo-Nazis).
Russia’s economy lacks the diversity one would expect in a major power, with more than 60% of its revenues coming from the energy sector. This Achilles heel, exposed at the same time that Western countries are piling on sanctions over the debacle in Ukraine, has caused the ruble to plummet and increased fears of runaway inflation. Average Russians naturally fear a return to the free-wheeling 1990s when a drunken Boris Yeltsin presided over a kleptocracy of epic proportion.
The U.S., the EU, Japan and China, huge economies that are all net importers of oil, are the main beneficiaries of today’s lower price. To use the U.S. as an example, if the price of oil stays around $50 a barrel, the average American stands to benefit to the tune of around $550 dollars a year, which will make a huge difference for many low-income people. However, we need to look at some of the larger effects this might have, especially on the financial system and the environment.
Strategic Genius or Suicide Pact?
We sometimes have to wonder if those in charge of our financial system actually talk to people in the foreign policy establishment. Sure, the interventionists in both the Republican and Democratic parties always tout free markets. But it often seems like they don’t understand how these markets actually work. The current oil deflation is a brilliant strategic move in terms of punishing official enemies, but when you factor in the damage it could cause to the financial system as a whole, it may be a little like shooting yourself in the face to remove a wart from your nose.
Energy companies tend to need significant capitalization, meaning they borrow lots of money for their operations. Lower oil prices mean new startups will have more trouble raising money and many ongoing operations will have trouble paying down the debt already on their books. Take the example of shale oil, or fracking. In order to be profitable oil needs to cost around $70 a barrel. If prices continue to stay this low, it could well end the shale boom and, with it, the dream some deluded people hold about an energy independent USA.
But the concern is not for the frackers and dirty tar sands producers who stand to lose their shirts in all this. Rather, we need to remember that the financial system is inter-connected. The too-big-to-fail banks not only have huge outstanding loans to these businesses; they also have vast amounts of oil derivatives, which they stand to lose in a big way if oil prices stay low.
Finally, we need to ask ourselves what the low cost of oil means for sustainable energy and green technology. With higher priced oil, green energy becomes more attractive. Because the technology is still relatively new, it remains somewhat expensive. Low-priced oil could set back the industry in the long term, as reported by the UK’s Independent. People also tend to drive more and purchase less fuel efficient cars when the price of oil is down, signaling more bad news for Mother Earth.
So, next time you see some smug politician like U.K. Prime Minister David Cameron bragging about how they are winning the economic war against some official enemy, remember that they might be playing a dangerous game of chicken with the stability of the financial system and the natural world held in the balance.