Oil markets stabilised this week, but prices remained below $65 per barrel – close to a five year low. As analysts rushed to assess the market’s health and the fallout from Opec’s November decision not to limit production. Brent Crude – extracted from the North Sea – has suffered particularly significant price falls and is down 41.55% on last year. It is of little surprise that BP has responded by announcing a £640 restructuring plan that will undoubtedly lead to job losses internationally. In Norway, so often hailed in Britain as a model nation when it comes to utilising its mineral wealth, interest rates were slashed to a record low as the government sought to guard against shocks to its economy.
Adding to pressure on prices is new data from the US Energy Information Administration, which reveals that refiners are producing at record levels, with no intention of slowing down. Saudi Arabia has vociferously resisted calls from smaller Opec nations to cut production as a means of rebalancing the market. In a statement before a United Nations meeting in Lima, Peru, Petroleum Minister Ali Al-Naimi asked “why should I cut production? You know what a market does for any commodity. It goes up and down and up and down.” There is little optimism that this situation will improve in the short term. Francisco Blanch, Head of Global Commodity Research at Bank of America, has predicted that oil prices will slump further to $50 per barrel in 2015. Oil will, Blanch suggests, enter a period of “disorderly trading” that, while benefitting petro-states like Saudi Arabia, will be detrimental to weaker oil producers, such as Nigeria and Iran.
With lower oil prices seemingly with us for at least the next twelve months it seems appropriate to ask whether they will lead to sweeping changes.
Challenging SNP Assumptions on Balancing the Books
In the run up to September’s referendum the SNP were keen to champion the idea that an independent Scotland could become one of the world’s wealthiest states per capita thanks to “24 billion barrels of oil equivalent, valued at £1.5 trillion.” This valuation was made on the basis that a. an independent Scotland would receive access to 90% of known UK hydrocarbon reserves, b. that the price of oil would remain steady at around $110 per barrel and c. that the per barrel cost of extraction would not rise. This was undoubtedly an overoptimistic assessment.
While the collapse of oil prices will be of concern to the UK government, they make up just 2% of total government revenue and can be viewed philosophically as a means to guard against inflation and perhaps lower consumer prices. For an independent Scotland, where oil revenues would be nearly 20% of government revenue, such musings wouldn’t be possible. Indeed, a price collapse of this nature would be catastrophic, greatly constraining Holyrood’s spending power. Perhaps more fundamentally, a fall in crude revenues will limit funds available for further exploration. Given the North Sea is already a relatively ‘expensive’ area to excavate it is likely that an independent Scotland could suffer from high extraction costs per barrel in the future.
It is notable that few senior Scottish politicians have pursued this line of questioning. While Alistair Carmichael, Liberal Democrat MP for Orkney and Shetland, has rightly pointed out that an independent Scotland would be susceptible to oil shocks, few others have been willing to take on the task. It is notable that Jim Murphy pointed to the SNP’s reliance on oil wealth as a major weakness in an interview with Good Morning Scotland in March of this year. Though the issue has fallen by the wayside somewhat, Murphy may well seize upon it if he is elected Scottish Labour leader as expected. A heavy dose of fiscal realism is unlikely to break the SNP’s core constituents, but wavering and moderate nationalists may well welcome an argument with a less rhetorical bent. Nicola Sturgeon has proven herself to be a canny operator and clearly connects with voters on the doorstep, however, her track record on financial matters is less positive. Indeed, in a recent interview with Sky News she erroneously claimed that projected oil prices in 2015 remained at “over $100 a barrel…the outlooks in the sector are very, very positive ones.” Such gaffes could well prove more costly if challenged.
Welcome Relief for Consumers?
Last week Chancellor George Osborne noted that wages for those in full-time employment for over twelve months was outstripping inflation, with real terms wage growth of 2% expected in 2015. Falling oil prices should help to support this fall in the cost of living. Indeed, both Merrill Lynch and Goldman Sachs have predicted that prices could fall by around 20% to a £1 per litre next year. Heating prices should follow suit, offering rare respite for customers used to ever-steeper prices.
The loss of revenues generated by oil companies should be offset by rising consumer spending. In Q2 2014, the largest outgoings for consumers were transport and housing, which combined totalled 37.8% of spending. The Treasury will undoubtedly hope that they will begin to shift their cash to other sectors, helping to stimulate growth in the flagging retail sector in particular. Although the May General Election may come just a little too early for George Osborne to reap the benefits of lower oil prices, he will no doubt be hoping that consumer confidence will help to bolster his bid to become Chancellor for a second term.
Fracking – A Revolution on the Rocks?
Since 2008 American oil production has risen from around 5 million barrels a day to over 9 million, thanks largely to the so-called ‘fracking revolution’. Along with fracking have come an estimated 600,000 jobs, many of which are high-skilled and well-paid. However, with falling prices the future of fracking has become uncertain. Common wisdom suggests that the extraction of ‘tight oil’ – derived from tight rock formations – is only profitable when prices reach $85 a barrel, with prices well below this mark questions will no doubt be raised as to its future.
In the UK the fracking revolution is still to arrive, however, investment has poured into geological surveys across the country. With returns likely to be lower than anticipated the nascent industry faces an uncertain future. Public support for fracking remains low and few public figures have been willing to champion the extraction method due to its perceived environmental impact. Given the levels of investment that firms like Ineos and Igas Energy have made in identifying suitable shale gas sites there is little doubt that fracking will arrive on these shores, however, the dire warnings from the green lobby appear in this instance to have been perhaps a little premature.
Russia – Putin Rejects the First Law of Petropolitics
In 2006 American journalist Thomas Friedman used an article in Foreign Affairsmagazine to introduce his ‘First Law of Petropolitics.’ Friedman key suggestion was that:
“the lower the price of oil, the more petrolist countries are forced to move toward a political system and a society that is more transparent, more sensitive to opposition voices, and more focused on building the legal and educational structures that will maximize their people’s ability, both men’s and women’s, to compete, start new companies, and attract investments from abroad. The lower the price of crude oil falls, the more petrolist leaders are sensitive to what outside forces think of them.”
If any state has bucked this trend it is Vladimir Putin’s Russia, which, in recent weeks, has begun to adopt ever more bellicose tones as its economy rushes into the red.
When oil prices were soaring, the Kremlin was able to amass foreign currency reserves worth upwards of $515 billion, including two hefty sovereign wealth funds derived from energy exports. However, this king’s ransom is beginning to dwindle. Foreign reserves have fallen by 20% in a year, the Bank of Russia has been forced to artificially prop up the ruble and the much vaunted sovereign wealth funds used to plug holes caused by Western sanctions.
The Russian economy is beginning to backslide and is sinking into a recession. While oligarchs and their offspring take shelter in the relative comfort of Monaco, Kensington and Paris, ordinary Russians are feeling the squeeze, and Putin risks alienating his core working and lower-middle class support. One notable drain may be pensions, with Rosneft, the state oil giant, pleading for $44 billion to prop up its payment system. The 2015 budget was also drawn up on the assumption that oil prices wouldn’t dip below $100 dollars a barrel, leaving a dramatic shortfall in cash.
The Kremlin’s response has been two-fold. First, it has tried to strengthen ties with India, with Putin meeting Prime Minister Narendra Modi in New Dehli to discuss energy, military and trade alliances between their two nations. Second, Putin has upped the nationalist ante, appearing on state television to call Crimea a place of “sacred importance” for Russians and perhaps turn popular anger towards the west, and not Moscow.
It remains to be seen how successful Putin’s strategy will be. Certainly his rhetoric will be concerning for government’s across the western world. Perhaps more importantly though will be how the Russian people respond to economic dislocation. To a leader who has never been particularly responsive to outside pressures, this may be a more important factor in how he approaches policy in the future. In any future dealings with Russia this must surely be a central consideration.
The falling price of oil is a subject that should demand the attention of anyone with an interest in politics, economics of business – whether local or international. While we in public affairs can at times fall into a localist silo it is vital that we see beyond this and recognise that factors far beyond the bounds of Whitehall may have seismic impacts upon our work. Similarly, it is essential that we use this information wisely and protect our clients, as well as possible, from troubled waters ahead.
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