This article was originally published on Fair Observer.
The major cause of the recent oil price fall is the increasing oil production in the United States, as advanced technology enables American oil companies to extract previously untapped shale oil and gas. Although remaining a major oil importer, the US now produces more than half of the oil it consumes.
One salient consequence that may have great geopolitical impact is that the US has overtaken Saudi Arabia as the world’s largest oil producing country. On the other hand, Saudi Arabia, the leading member of the Organization of Petroleum Exporting Countries (OPEC) and the world’s largest oil exporter, is unwilling to cut its oil production to reduce global oil supply. At a recent energy forum held in Abu Dhabi, Saudi Oil Minister Ali al-Naimi restated Riyadh’s policy of not cutting oil output, and blamed the non-cooperation of non-OPEC member oil producers for the drop of oil prices.
Will Oil Remain Cheap?
The reason why the OPEC members refused to cut oil production is two-fold. First, they would like to see low prices drive American competitors out of the market. The cost of conventional oil extraction is much lower than the cost of extracting shale oil, which can be up to $90 per barrel. If the oil price remains lower than the cost of extraction, American producers may not be able to afford it and will stop drilling shale oil.
Second, as Saudi Arabia claimed, cheap oil is good for the global economy, and reviving economic growth will increase the oil demand, which eventually will lead to higher prices. In the words of al-Naimi: “[C]urrent prices … stimulate global economic growth, leading ultimately to an increase in global demand and a slowdown in the growth of supplies.”
OPEC’s efforts to curb shale oil production through market forces, however, may not be successful. While the costs of producing shale oil and gas are high, most of them are sunk costs that were already made. So far, only two US shale companies have stopped drilling shale oil due to low prices, but other companies still continue their production. In the long-term, there is little reason that American oil companies will exit the global oil market.
The second wish that increasing global economic activity caused by cheap oil will heighten demand on oil is even harder to achieve in the short-term. While emerging-market countries can take advantage of low oil prices and accelerate economic development and growth, the increasing demand for oil will be offset by growing oil production. So, does this mean an era of low oil prices is coming?
The answer is yes, at least for the short-term. As Saudi Arabia reiterated its reluctance to cut oil supply, we do not see any indication that the oil price will return to its peak. The US Energy Information Administration predicts that oil will remain cheap in 2015, with the monthly average price around $63-73 per barrel. But how long the low price will last is hard to predict, because there are other factors that are still unclear and that may affect the global oil market, such as conflicts in Middle East.
Low Oil Prices: Good for Asia?
Low oil prices seem to benefit most countries, even oil producers. As long as the price does not fall below the level that OPEC members can withstand, they still profit. For other countries, low energy costs should be beneficial to consumers and to most industries, especially the transport and refining industries. After all, research has shown that what is harmful is not oil prices per se, but rather the instability of oil prices.
Asian countries are mostly oil importers, so the Asian economy should take this advantage and benefit from low oil prices. China, for example, should be one of the winners. Beijing‘s growing reliance on imported energy is a big concern to the economy and to national security. As the US domestic supply of oil has been increasing, China is now the world’s largest net oil importer. Its demand on energy, despite the slowdown, is expected to continue escalating.
While the oil demand from China will be an important determinant of future oil prices, the current low price is a good opportunity for the country to develop its economy, to lower inflation and to increase strategic oil reserves, which China has already started to do.
Low oil prices also help Asian governments lower their spending and reallocate the saved money. Malaysia and Indonesia are oil exporters and can potentially be harmed by the fall of oil prices. But both countries cut their oil subsidies that have long been a major financial burden on their governments. As Indonesian President Joko Widodo pointed out at the recent Asia-Pacific Economic Cooperation Summit in Beijing, the money saved from the oil subsidy cut will be channeled to more productive sectors, including infrastructure. This is the correct direction governments should pursue when the oil price is low.
So, it may not be clear for how long we can enjoy the cheap oil, but it will be hard to see $100 per barrel again in the near future. Low oil prices should not just benefit individual car owners. They should provide a good opportunity for governments to carry out policy adjustments or reform.