Cheap

From all indications, we are in for another substantial rollback in fuel prices over the next couple of days.

The price reductions of the past several weeks have resulted in lower minimum fares for public transport and a marked decrease in our inflation rate. Further rollbacks will enhance consumer benefits even more.

One American economist argues the drop in fuel prices is the equivalent of a tax cut. It gives consumers greater purchasing power. The average US household is now estimated to be saving $500 a month in fuel bills since oil prices began receding.

That amount goes either to increased buying, which benefits retailers, or increased savings, which boosts capital.  Either way, lower fuel prices will boost economic activity — except in economies reliant on revenues from fuel exports.

What is the ideal price for fossil fuels?

No one knows, really. There is nothing mystical or transcendental about prices. Price is simply the amount at which contracting parties agree to transact.

The consumer in me thinks that oil prices should move as close to zero as possible. That, however, could lead to another set of problems, including an uptick in pollution levels, profligacy and the termination of efforts to seek greener sources of energy.

The economist in me frets about the possibility that fuel prices have become too cheap. Anywhere lower than where prices are now (about $60 per barrel), distortions in the global market could become evident.

$60 per barrel is a significant point. That is the break even price to keep extraction of oil from shale sustainable. The development of new technologies to enable extraction of oil from shale caused the US to become a net oil exporter. That is a major reason for the drop in global oil prices.

When oil prices drop, the price of natural gas drops even more significantly. If oil is cheap, natural gas is even cheaper. However, the low price for gas might make extraction of the commodity a negative business proposition. We might also see a shift away from gas back to oil. That is not good in the long run.

Dropping oil prices does not benefit all countries uniformly. Some economies might be happy about dropping inflation rates. Other economies might be pushed into ruinous deflation.

The drop in oil prices is unwelcome in at least three countries: Russia, Iran and Venezuela.

Russia and Iran, both subject to international trade sanctions, are almost entirely dependent on oil exports to keep their economies going. Both economies have been in recession before oil prices began softening dramatically, due largely to sanctions imposed on them (Iran for her nuclear arms program and Russia for belligerent actions towards Ukraine). Dropping oil prices could depress their economies further, leading to political volatility.

Venezuela is a funny country. Once Latin America’s wealthiest economy per capita due to being the hemisphere’s largest oil exporter, the economy has deteriorated almost as badly as Zimbabwe did in Africa. The main reason for this is the policy of its crypto-socialist leaders to use oil revenues to satisfy populist demands rather than to build strong domestic market fundamentals. The policy led to hyperinflation and diminishing economic productivity.

A lower oil price regime will curtail the extensive subsidies given out by the Venezuelan government. This, too, could invite intense political unrest as the faux socialist project is revealed as nothing more than unwise state patronage.

Right now a large segment of Venezuela’s population is dependent on state dole outs, pretty much like we have a large constituency dependent on the conditional cash transfer program. When the dole outs end, there will be widespread disillusionment.

There is a theory that OPEC, largely controlled by Saudi Arabia, did not move to curtail production in order to forestall the development of shale oil industries. I submit a contrary view, however. OPEC has not moved to shore up oil prices simply because it can no longer dictate oil prices. If OPEC cuts its production levels in a vain effort to prop up prices, non-OPEC exporters like Russia and Iran will simply scale up their exports because they desperately need the revenues.

The Age of OPEC is probably over.

Just a year ago, the prevalent view was that the margin between oil production and fuel demand was too thin. That invited speculation that pushed up prices to well over $110 per barrel.

Now we face the reverse situation. With OPEC maintaining its production levels and US strategic oil reserves filled to the brim, the margin between supply and demand is now too fat.

The surplus is so robust no one really bothers about the availability of Libya’s production. The country is enmeshed in a low-grade civil war between tribal militias, but the rest of the world prefers to ignore it. Suddenly Libya’s oil has become irrelevant.

So too may Iraq’s oil production become irrelevant. As in Libya, the rest of the world may become complacent about violent sectarian and tribal troubles plaguing that country. It could well approximate the same complacency that allowed the Syrian civil war to progress to insane levels and take so many lives.

In this episode of cheap oil, the sellers have lost much clout. After years of holding the rest of the world hostage to their supply, the traditional oil exporters have lost the ability to inspire awe.

Instead of fretting over oil supply, the world now looks after the economies that might drive global growth. Those will have to be the economies best able to quickly translate cheaper oil into greater productivity.

We can aspire to make our economy one of those, but only if we are able to break the chokehold of backward infra.