Recovery

For the fourth consecutive weekend, oil prices were slashed substantially. The outlook is for more price cuts the next few weeks.

Over the weekend, spokesmen for the once mighty OPEC announced the organization has no plans to cut production. No emergency meeting of the cartel is scheduled even as oil prices have fallen by 40% the past few weeks and a supply glut is obvious.

The members of the cartel will continue pumping 30 million barrels a day notwithstanding the obvious supply glut. OPEC spokesmen made it clear that if any production cuts will be made, it will be by non-member countries. Among the non-member countries are the US and Russia — neither expected to curtail their respective outputs of hydrocarbons.

The laid-back attitude of the OPEC is uncharacteristic. In the past, the cartel held an emergency meeting as soon as oil prices softened. Such meetings typically involved negotiations among the members on how much each oil producer would cut back production levels. That is clearly not happening this time.

The single biggest addition to global production levels come from oil extracted from shale in the US and Canada. New drilling technologies have made this possible. The same technologies, adopted elsewhere, will make it possible to tap previously inaccessible oil deposits to further supplement global supply.

The implication is obvious. Abundant supply will keep oil prices low for a very long time — unless, of course, the companies tapping oil from shale go bankrupt.

According to industry analysts, the break even price for the shale drillers is $60 per barrel. The reluctance of OPEC to curtail production guarantees the commodity will trade below the $60 per barrel level, which is exactly where it is now.

If production is kept at present levels, oil could drop to below $50 per barrel. One industry analyst predicts this could fall to as low as $20 per barrel if the margin between supply and demand widens.

As in most other things in this world, the pain is unevenly distributed among the oil producers.

Venezuela, the biggest oil exporter in the Western Hemisphere before shale oil came into play, based its domestic spending plan on the assumption of oil selling at $120 per barrel. At present oil price levels, Venezuela will have to drastically cut back domestic spending.

Venezuela will also have to cut back on the heavily subsidized oil it supplies Cuba as an expression of their “fraternal” socialist ties. That prospect might have contributed to Cuba’s sudden willingness to reestablish friendly relations with the US.

Last week in dramatic fashion diplomatic ties between the US and Cuba were restored, the single biggest foreign policy achievement of the Obama administration. Cuban president Raul Castro delivered a major policy speech that was uncharacteristically friendly towards the US. This was after Washington announced the lifting of the economic embargo on the island.

Venezuela could be the place where dramatic political change directly traceable to the drop in oil prices will happen. The country, once Latin America’s wealthiest per capita, is now the region’s most impoverished. This is due to the eccentric “socialist” system introduced during Hugo Chavez’s rule and continued by his successor. This variety of “socialism” involved channeling oil revenues to populist spending plans even as domestic industries declined.

Without robust oil revenues, Venezuelan-style “socialism” loses its foundations. In a deeply polarized society, this could lead to unwholesome political consequences.

Russia is the next most severely affected economy. Putin’s spending plan assumed oil prices, 75% of the country’s revenues, at $100 per barrel. Oil prices will, clearly, not approximate that assumption anytime soon. This is the most immediate cause for the fall in the ruble’s exchange value.

The collapse of the ruble is magnified by Russia’s heavy reliance on imported consumer goods. The country’s oligarchic economy and continued centralization limited the growth of small manufacturers responding to consumer needs. As a consequence, Russia imports as much as 70% of its consumer goods mainly from Europe.

The dramatic devaluation of the ruble will make life difficult for ordinary Russians. Consumer goods will soon be inaccessibly priced. There will be much grumbling in the streets.

The drop in Russian consumer demand, however, also negatively affects European companies selling products to Russia. European companies dependent on Russian sales fell in the continent’s stock markets. Since these consumer goods in turn use raw materials imported from the rest of the world, the chain reaction will be a long one.

Putin’s domestic popularity has been sustained by churning up the powerful force of Russian nationalism. Now, with low oil prices, his regime will have to be revalidated in the cruel terrain of economics.

Like Russia, Saudi Arabia’s domestic spending plan also assumes oil to be selling at $100 per barrel. The drop in oil prices will force spending cutbacks in the kingdom and the Gulf states. With large international currency reserves, however, they are expected to endure the winter of cheap oil for some time.

If oil remains cheap for too long, however, the legitimacy of the medieval regimes in this region could be eroded as well. As in Venezuela and Russia, expensive oil has been the basis for artificially propping up forms of rule considered obsolete elsewhere, especially among countries that need to renew their legitimacy on a daily basis.

The OPEC justifies its reluctance to cut back production in the face of growing oversupply of the commodity by saying global economic recovery will eventually solve that problem. That is uncharacteristic good-natured optimism from the cartel that brought the world many recessions in the past.

Nevertheless, we hope they are right. The world needs economic recovery badly.