Oil is the most valuable commodity in world trade, so any significant change in its price—whether upward or downward—has far-reaching economic consequences. Because oil also plays a pivotal role in world politics, such shifts can have equally momentous implications for international relations. It is hardly surprising, then, that the recent plunge in prices has generated headlines around the world. Many giant energy firms have announced massive cutbacks in employment and investment, and major producing countries like Russia and Venezuela have been forced to scale back government expenditures. While some analysts speculate that prices have now reached bottom and will soon begin climbing again, there are good reasons to believe that this descent is not just another cyclical event but rather the product of something far more profound and durable.
Before examining these factors, let’s consider the sheer magnitude of the price collapse. Last June, Brent crude was selling at about $115 per barrel, ensuring substantial wealth for the major oil corporations and oil-producing countries. Most analysts assumed, moreover, that prices would remain at this elevated level. As recently as October, for example, the Energy Information Administration of the Energy Department predicted that the average price of crude in 2015 would be $102 per barrel, about the same that it’s been for the past five years. Just three months later, Brent had fallen to as low as $46 per barrel, with some experts predicting a further slide into the $30s.
Why this sudden plunge in oil prices? That old mantra, supply and demand, is mostly to blame. The high prices of recent years have been driven, in large part, by ever-increasing demand from China and other rapidly developing countries of the Global South. Chinese consumption jumped from 7 million barrels per day in 2005 to 11 million in 2014; comparable increases were posted by India, Indonesia, Brazil and Saudi Arabia. Production increased to satisfy all this added demand, but not always fast enough to keep up—thus explaining those high prices. Over the past six months, however, the fundamentals have shifted. The economic doldrums in Europe and tepid growth elsewhere have resulted in less than expected levels of demand, while the flow of crude from America’s shale formations has reached flood proportions, producing a glut of supply and driving prices downward.
Historically, the major oil powers have responded to falling prices by reining in production, thereby constricting supply and reversing the slide—but not this time around. Saudi Arabia, which lost market share to its rivals after pursuing this strategy in previous price declines, has chosen to keep pumping at current rates. At the same time, several producers, including Iraq and Russia, have increased their output. But with the US market inundated with cheap domestic shale oil and demand shrinking elsewhere, the Saudis and their competitors have been forced to lower prices in order to attract customers in non-US markets. Some have speculated that the Saudis also hope that low prices will force the Russians into curtailing their support for the Assad regime in Syria; but retaining market share appears to be their principal objective.
Whatever the combination of factors at work, the plunge in prices is having far-reaching consequences. For countries that depend on oil revenue to finance government operations, the price collapse has already inflicted serious damage. Major producers like Mexico, Nigeria, Russia and Venezuela have announced budget cutbacks, significantly impairing the ability of these governments to implement favored domestic and international programs. Russia, for example, is under pressure to reduce its military expenditures, calling into question its ability to undertake major military operations in Ukraine or other peripheral regions. Mexico has announced a budget reduction of $8.3 billion, eliminating funding for prestige projects favored by President Enrique Peña Nieto, who is already facing strong popular opposition because of rampant corruption and lawlessness at the local level. The Venezuelan government, which has long relied on oil revenue to finance social programs aimed at lifting the status of the poor, is now scaling back its efforts—further eroding public support for the socialist government of Nicolás Maduro.