How Collapsing Oil Prices Will Disrupt the Global Economy
When oil prices began to fall from their highs of nearly $110 a barrel in mid-2014, the expectations were that the price of oil would likely fall around 50% and then stabilize before rising again in the near future. In fact, few experts were predicting that oil prices would fall much further or that they would stay at a lower level for a prolonged period of time. By mid-2015, it appeared that oil prices had stabilized at near $60 a barrel and, while this represented a 45% decline from their mid-2014 highs, this was nevertheless a level that would suit many of the world’s leading oil producers who were worried about the impact of soaring oil production levels in the United States. However, oil prices began to slowly trend downward again in the second half of last year and this decline has turned into a collapse over the past two months, with oil prices now below $30 a barrel, a 75% decline from their level just 18 months ago. Moreover, there are few indications that oil prices will rebound in the coming months and, in fact, they may yet fall to even lower levels in the near future.
This is not the first time that the world has experienced such a dramatic fall in the price of oil. However, there is only one example of such a decline that resulted in a prolonged period of lower oil prices. This was the fall in oil prices in the early 1980s that followed the two oil shocks of the 1970s. After peaking at more than $110 a barrel in 1980, oil prices fell by nearly 50% over the next five years, before collapsing in 1986 to levels that were more than 75% lower than their 1980 peak, a similar decline as the one that has happened in recent months. However, this decline was even more gradual than today’s, as the recent collapse in oil prices has taken place over a period of just 19 months. During the collapse of oil prices in the 1980s, Saudi Arabia attempted to cut production to boost prices, but other leading oil producers failed to follow suit and Saudi Arabia ended up losing market share, while suffering from the impact of lower oil revenues. More importantly, the fall in oil prices in the 1980s devastated the Soviet Union’s economy (which had grown dependent upon oil and gas exports), leading to the collapse of the USSR just a few years later. Finally, the oil price collapse in the 1980s stunted the growth of the oil industry in all but the countries with the cheapest oil production costs, a development that reverberated well into the early 21st century.
While it remains to be seen how the current collapse of oil prices will alter the global economy and the oil industry, there are a number of changes that are likely. First, oil dependent economies will continue to suffer from a sharp fall in oil revenues, forcing them to make major public spending cuts that will push many of these economies into major slowdowns. For countries such as Russia, Iran and Venezuela that need high oil prices to balance their government budgets, this fall in oil prices will have a particularly devastating impact that could begin to impact the political situations in these countries, much like the oil price fall in the 1980s doomed the Communist regime in the Soviet Union. For traditional oil producers such as Saudi Arabia, Iran and the Gulf countries, this fall in oil prices could add to the already considerable political tensions in that region. Meanwhile, non-traditional oil producers such as shale industry in the United States, the oil sands industry in Canada and the expanding oil industries in many Sub-Saharan African countries will certainly suffer from sharp declines in investment and output, causing pain for those regions that were counting on rising oil revenues for much of their economic growth. Finally, the rapidly expanding alternative energy sector that had benefitted from the high price of oil could see a sharp fall in investment, even as governments have vowed to significantly reduce greenhouse gas emissions in the coming years.
The big question going forward is whether or not oil prices will remain as low as they are now or if they may even fall further in the months ahead. As was mentioned already, there has been only one steep fall in oil prices since the Second World War that resulted in a prolonged period of lower oil prices and this was in the 1980s, as all other previous sharp declines in the price of oil were followed by a quick return to higher prices. However, all signs at the moment are pointing to the likelihood that oil prices will remain relatively low for the foreseeable future. First, supply levels remain very high as production levels in the world’s two leading oil producing countries, the United States and Saudi Arabia, have not fallen and Iran is in the process of re-entering the oil market as sanctions are lifted on that country. In addition, Iraqi oil production levels are also rising rapidly, despite the unrest in that country. On the demand side, there had been expectations that demand levels would continue to rise at a rapid pace in China and other emerging markets, while the recovery of the world’s leading developed economies would also boost oil demand. Instead, Chinese demand has fallen well below expectations and many other key oil markets have experienced lower demand growth levels than had been forecast a few years ago. As a result, it will take a rather dramatic turn of events, such as oil production cuts within OPEC or a conflict in the Gulf involving Saudi Arabia and Iran, to return oil prices to higher levels. Without such developments, the price of oil will remain low and could fall further in the months ahead, causing major political and economic disruptions around the world.