The Middle East is in Crisis. So Why is the Price of Oil Plunging?

A terrorist group is seizing key oil fields in northern Iraq. Libya lacks a definitive central government. The United States and the European Union are actively sanctioning two of the world’s top five oil producers, Russia and Iran. Five years ago, the current geopolitical climate may have been cause for a surge in oil prices, but today it is the backdrop of a fall to the lowest price level oil has seen nearly in four years. The precipitous decline can be attributed to a complex web of geopolitical and economic factors, spanning from Ecuador to China.

Among the biggest differences in the oil market of today and the oil market of just a few years ago is significantly stronger US production. As oil prices have increased, increasingly expensive techniques for getting oil out of the ground have become profitable. Techniques such as hydraulic fracturing, or “fracking,” have allowed billions of potential barrels of oil to be drilled from American territory in places like the Bakken Shale in North Dakota. Indeed, according to the Energy Information Administration, American oil output has increased a remarkable 70% since 2008, as we displaced both Saudi Arabia and Russia en route to becoming the world’s top producer in 2014.

A clear casualty of the American shale boom has been African oil producers, who produce a similar product of high quality crude to that which is being produced in North Dakota.  Among the most affected African producers has been Nigeria. In 2006, the country was selling about 1.3 million barrels per day to the United States. While that number had fallen to half a million by 2012, Nigeria still ranked as one of America’s top five oil exporters. Now, just two years later, Nigeria has completely stopped exporting to the United States, sending its goods instead to eager Asian customers such as Japan, China, India and South Korea. Analysts believe Angola, Libya, and Algeria, Africa’s other main oil producers, will also begin to increasingly look towards the Asian market.

Another key reason for the decline in domestic oil prices has been the strength of the US dollar. The Federal Reserve has recently signaled it will end its bond-buying program, which by raising interest rates will strengthen the dollar. Also critical in the dollar’s rise is that the US economy is quite simply outperforming developed economies in Europe and Japan, and even developing economies in Latin America. A strong dollar leads to lower oil prices because it means that prices of imported oil will be cheaper.

With oil on the decline, a big question is how the members of OPEC, the cartel of oil producing nations that seeks to manipulate the price of oil, will respond. Many countries need triple-digit oil prices to balance their budget. For example, with Brent Crude’s $90 October 10th closing price, 8 OPEC members – Iran, Venezuela, Nigeria, Algeria, Ecuador, Iraq, Angola, and even Saudi Arabia – all are running budget deficits. Saudi Arabia has already acted decisively, increasing crude output by 107,000 barrels a day to and reducing its export price to Asia to its lowest point since December 2008. The move sent a strong signal to the market: Saudi Arabia is willing to compete for market space in Asia and, importantly, isn’t afraid to get into a price war. The potential for a price war within OPEC is a realistic one and one that could send oil prices plunging even further. Soon after Saudi Arabia’s announcement, Iran announced an identical cut to Asian delivery prices. Even Libya, despite having two rival parliaments competing for legitimacy and an active Islamist insurgency in its east, plans to increase production from 1 million barrels a day from below 200,000 barrels a day in May. With members split on reducing supply to raise prices and cutting prices to preserve market share, OPEC’s next meeting, looming on November 27th, promises to be an important one.

The decline in the price of oil can also be attributed to a weakness in demand. The International Monetary Fund cut its global economic growth forecast from to 3.3% from 3.7% in April. The report put the chances of a third Eurozone recession since the financial crisis at 40%. Germany, the largest economy in the Eurozone, is of particular worry. German exports plunged nearly 6% year-over-year in August, its biggest drop since the heart of the financial crisis. Developing economies are also seeing weakness. With the ruble at a record low versus the dollar and western sanctions stinging industry, the World Bank is forecasting Russia to grow at just 0.3% in 2015. Brazil, one of the world’s top 10 consumers of oil, slipped into a recession in the second quarter. And Chinese growth, averaging over 9% between 2009 and 2011, is forecasted by the IMF to fall to 7.4% this year and to 7.1% in 2015.

With the potential for a price war in OPEC looming and weakness in the global economy, it is no surprise oil is well off its June peak. Without a change in global fundamentals, however, it will be difficult for oil to return its old price levels in the near future.

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