The economic and political effects of the decline in oil prices

A further professional lecture organized by the Association of Diplomacy in Practice was delivered on the 23th of March, 2016 in order to analyse the international effects of the decline in oil prices. This time the invitation of our association was accepted by András György Deák, senior research fellow, and head of Research Group on Development Economics of the Institute of World Economics of the Hungarian Academy of Sciences, Diána Szőke, research fellow of the Institute For Foreign Affairs And Trade, György Drucker, energy expert, and director of the Ex Libris Consulting Ltd, and Tamás Szigetvári, senior research fellow of the Research Group on Development Economics of the Institute of World Economics of the Hungarian Academy of Sciences. The lecture was entitled:  “The economic and political effects of the decline in oil prices”. Within the framework of their high standard and thrilling lecture, we looked for the answers to some questions, such as “which factors and reasons generated the decline in oil prices in the last period?” “How did the crisis influence the home and foreign political relations of Russia, China, North Africa, the Middle East or even Hungary, and what kind of change was effected by the crisis relating to the volume of the oil export?” “What kind of possibilities are there to eliminate the disadvantages from the crisis?” and “What is the relationship between oil and alternative energy sources and, in connection, what will the oil prices look like in the next years or decades?”

Relating to the factors generating the decline in oil prices György Drucker emphasized two important points: from the 2000s there was a shock of supplies in the oil market, the price of oil increased from 9-11$/barrel to 50$/barrel in 2005, and 120$/barrel between 2006 and 2007, then reached the top price of 147$/barrel. The forward rate was low, while the spot rate was very high. Because of the situation of the Chinese economy there was a shock of demands so as a result of the economic crisis in 2007 and 2008 the oil prices slightly decreased, and after increased again to 100$/ barrel. From 2014 another shock of demands appeared, which required the establishment of new oil fields (e.g. deconcentrated fields) and methods (ripping with water), as almost 30% of the geological resources had to be transformed to industrial ones to eliminate this problem. Today the amount of oil demands and supplies are more or less parallel. Capital market is another essential factor, because the change of the demand-supply relation highly depends on the rate of the dollar.  It is also essential that 50-60% of the world’s oil production are financed at the international level from the United States and huge oil concerns, whilst the small oil firms have rather slim intellectual capital and technical abilities. In connection to this topic András Deák mentioned, that in light of the 150-year-old existence of the modern oil industry even 7-8 times larger volatility than today can be viewed as absolutely normal. Because of the OPEC, the oil industry always managed to stabilize itself very easily. Unlocking of the sanctions applied against Iran and the potential oil surplus rooting in it may be a bit problematic, but it will consolidate in 4-5 years’ time. Tamás Szigetvári observed that a surplus of supplies appeared in the case of Saudi Arabia. Earlier the amount of Saudi oil production was limited by the OPEC, which was ideal for smaller states, because they were able to extract more oil for more money, but with the disappearance of the OPEC-limitation, the amount of oil significantly grew. This reduced the costs of alternative energy resources. However it is important to observe that for Saudi Arabia it is worth to produce more oil even if costs reduce, as it is a good way to reduce the political and economic influence of Iran and to crowd out its regional rivalries from the oil market. At the same time, because of lower prices not only will the income, but also the measure of the subventions reduce, which leads to the decline in demands and a surplus in supplies. According to Diána Szőke the changes in oil prices are rather mid-term changes and only the slate-oil mining could have a significant short-term effect. However, there is enough “original” oil, so there is no need to increase the “slate-oil”-production. Relating to the effects of low oil prices taken to the Hungarian economy, András Deák mentioned that for Hungary as a country being poor in mineral oil in need of oil import the low price on one hand is a good possibility to gain some surplus in trade, but on the other hand even the cheapest oil may be very expensive for the people due to the very high general business tax and value added tax. (The inelastic oil price is ideal to increase state income through different taxes.) According to Diána Szőke, in spite of the oil price decreasing by 75% at worldwide level, this decrease isn’t realized on the level of the people because of the high taxes and the fluctuation of the dollar-forint rate. In connection to that, György Drucker mentioned that the price of the oil decreasing from 400 to 300 Ft means 120 billion Ft saving per year and the price of gas decreasing to half as a result of the economical agreement between the Hungarian government and Gazprom. However this decrease appears only at the state level, MOL has a researching and a refinery segment and every loss in the researching part appears as a gain in the refinery sector and vice versa; so the low oil price means increased gains in the refinery sector, which can increase the refined oil production, an essentiality for the developed economies. According to Tamás Szigetvári the traffic industry being very dependent of oil, the increasing oil prices lead to the decrease of the price of alternative energy resources, and vice versa.

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Regarding the effect of the low oil prices taken to the petrol-exporting countries, András Deák said that despite of the high level of petrol export and the well-structured industry, Russia doesn’t depend from the oil as significantly as it is thought. The oil annuity given to Russia by the World Bank was only 16% in 2012. (E.g. In the case of Saudi Arabia and Kuwait this value was 50%, in the case of Azerbaijan was more than 40%, and in case of Norway it was 10%) Today the oil export gives 27% of the Russian GDP. The ulterior effects of the sanctions introduced by the EU may be the most significant problem, because they limit the possibilities of the economy. According to György Drucker, the main problem is not the changes of the oil price, but the foreign currency exchange rate. Using the rouble in the oil industry may be a good solution, but András Deák added that the oil prices are highly linked to the rate of the dollar. He also mentioned that Russia linked the rate of the rouble to the rate of the dollar, and lost 90% of its financial reserves. In the 2000s Russia introduced reserve-defending sanctions in order not to have to link the rate of the rouble to the rate of the dollar, but in 2007 and 2008 the price of the oil decreased from 150 to 0,25 dollar, then increased again up to 100$ This problem could be eliminated only by countries that linked the rate of their currency to the rate of the dollar, what Russia didn’t want to do. This means that there was no bankruptcy in 2008, and even a small economical increase could be visible. However there were and there are no radical structural changes in the economy, which makes the economic restoration extremely problematic for Russia. Tamás Szigetvári mentioned that Middle Eastern states highly depend on oil. Compared to other states of the region, Saudi Arabia has the lowest dependence, but in spite of that it has a relatively small population, and a significant, 6-7 billion financial reserve; yet there is 90-120 billion dollar shortage in the yearly budget, even if the oil price is determined at 100-120$/ barrel. So Saudi Arabia can not reduce the oil prices as it can lead to the decrease of living standards, the legitimation of power, the instability of the state, and the diversification of social transfers. But if the oil prices are too high, it may deflect the appearance of cheap imports, which may almost totally abolish the subsidies resulting in the appearance of unemployment. Diána Szőke said that not only the oil prices but other social and economic factors, like the Arab Spring, the Islamic State and economic reforms must be taken into account. Venezuela and Nigeria are even more problematic. In Venezuela the income coming from the oil export decreased by 90%, and the price of the refined oil increased by 1000% and an inflation rate of 140 – or according some economists – 300% can be seen. The country may need credit from China. In Nigeria the income coming from the oil export decreased by 75%, and export and other trading activities are impossible to execute because of Boko Haram. According to Tamás Szigetvári, some Middle Eastern States (e.g. Saudi Arabia) have to decrease the volume of their exports and outputs, and have to contain the volume of production. At the same time, Iran has to increase the volume of its export and outputs to create the economic balance, while Iraq has to become a stable and unified state.

In connection to the relation between the significance of oil and renewable resources Tamás Szigetvári observed that renewable resources can’t be ignored, mainly because of climate change. According to András Deák, the oil only preserved its dominant role in the traffic industry, however even in 2020 the oil will constitute 70% of the energy production in the mentioned sector. György Drucker observed that oil and renewable energy are not counterparts, but complements of each other. Renewable energy resources have a special financing system and don’t appear at the international level whilst often being financed by simple consumers. In the case of electric vehicles we cannot talk about economic considerations or prestigious investments. At the same time “traditional vehicles have more material supplements and established infrastructure”. The hybrid vehicles are realizable conceptions, but fully electric vehicles may become generally accepted in 30-40 years’ time.

Relating to the significance of China András Deák said, that the Chinese economy had 6-7% of economic development per year 100 years ago, today this value is 10-12%. China is one of the most raw-material-dependent economies in the world. Today China uses 50% of the mined coal of the world. The current period of Chinese economic consolidation indicates the changes in demand of energy resources by the surrounding countries (Vietnam, Indonesia)

As regards to the future changes of the oil price, György Drucker said, that the nadir of the oil price is 30$, this may increase with the appearance of the slate oil to 40$, in the next year prices may reach the ideal 60$ price point, and in 30 years’ time it may increase to 100$, if nothing extraordinary happens. According to András Deák, the main reason of the surplus in supplies created by the United States is that it’s not worth producing at 50$. It would be good if Saudi Arabia and the OPEC reached a consensus on the ideal price: 60$/barrel, but this requires efficient functioning and rational decisions from OPEC’s part. If there are enough oil reserves prices may decrease to 30$. According to Tamás Szigetvári, decreasing oil price leads to conflicts and the production competition may eventuate budget limitations even if prices are high. It would be better to apply an ideal price and new producing methods in order not to destroy the oil market, while Diána Szőke added that the change in the oil price depends on how long the Chinese economic recession lasts.