The world oil market is a complex system in which producing countries and importers participate, and the price of oil and economic fluctuations depend on their interaction. The last five years are characterized by a noticeable crisis in the current structure of the oil market, which is reflected in the volumes of resource extraction and its cost. The purpose of this work is to review and analyze the case study on the possible causes of the crisis, research the current situation in the oil market to predict possible changes in its structure.
“The Oil: Betting on Prices after the ‘Big Drop'” case describes the situation of oil prices falling in 2014-2016 through the prism of a hedge fund manager’s perception. This manager, Jane Dough, tries to understand the reasons for such a fall and predict the future of the oil market that allows the reader to familiarize themselves with the details of its work. However, despite the abundance of arguments and facts, the case does not have a single conclusion, and all the ideas of the author are only assumptions.
The Stable Decline of Prices and Its Causes
The decline of oil prices is a disturbing event for developing exporting countries since their budget suffers significant burdens if the low cost of resources remains for a long time. The period from June 2014 to December 2015 was a test for such countries as the price of oil fell from $ 115.19 to $ 36.61 per barrel (Ghez 1). This process had been developing gradually but with quite sharp changes and attempts to raise prices.
The main reason for the first wave of the recession was the oversaturation of the market with supply in the absence of demand. Oil, like any other product, responds to changes in market conditions, so countries have to reduce or increase the extraction of resources. The author calls one of the reasons for the decrease in oil demand a change in the preferences of countries and buyers, which switch to alternative energy sources, adapting to modern trends (Ghez 3). The development of electric vehicles also belongs to the same reasons, since the automotive industry is one of the primary consumers of oil (Ghez 8). People and governments increasingly abandon fuel vehicles that pollute the environment.
Another reason was that OPEC has been losing its former influence on the formation of oil prices and production volumes. Non-member countries develop their technology and increase oil extraction to make big profits from imports. The lifting of sanctions against Iran also has grown oil reserves because the state has tried to restore its profits in previous years (Ghez 2). Thus, oil reserves have increased, and oil prices have fallen since supply has been higher than demand.
Saudi Arabia as a Catalyst for the Crisis
Another major reason for the continued decrease in prices was Saudi Arabia’s refusal to reduce production. The author gives several hypotheses about such behavior of the Kingdom and its influence on the world oil market. The first of them is the desire of Saudi Arabia to eliminate small but numerous competitors from the structure of the world oil trade. The Kingdom could keep an oversupply on purpose so that low selling prices hit the budgets of developing countries and small companies. Consequently, if companies close and countries reduce oil production, unable to withstand the burden on the budget, the prices will rise but not affect the trade volumes of the Kingdom.
The second reason is also logical and associated with the destabilization of the economy of the main political and economic competitors in OPEC – Russia, and Iran. Saudi Arabia can survive low prices for a rather long period, replenishing the budget with its gold reserves; however, the weaker economy of Russia and Iran may not be able to withstand the pressure (Ghez 7). States may enter a period of crisis and lose both their pace of oil production, economic, and political influence. Thus, the refusal to lower oil production may be the geo-economics move of the Kingdom against competitors.
The author also develops a hypothesis that such behavior of Saudi Arabia is aimed at destroying or slowing down the pace of development of shale oil production by the United States. The new fuel produced by the USA turned out to be a new profitable alternative, which brings significant profit to the state and reduces the demand for traditional oil. Saudi Arabia views this trend as negative for its economy, so it hopes to decrease the income of US oil companies that also develops new shale oil fields by maintaining low oil price (Ghez 7). Thus, a decrease in the US supply of a new type of fuel will increase the demand for resources mined by Saudi Arabia. However, at the same time, all these forecasts are inaccurate and doubtful, since no one can say for sure that the Kingdom can survive low prices and its politics affect the market structure, as expected.
Alternative Causes and Scenario
One of the final thoughts of the case is the possibility that the decrease in demand and oil prices exists due to a change in global trends in energy consumption. It is possible that the world has been gradually abandoning oil as the primary source of energy production and switching to alternative ones, and this process is no longer reversible. This assumption also explains the behavior of Saudi Arabia, which does not want to reduce oil production, since it wants to receive maximum profit even for low-cost oil by the time when demand for it disappears. Nevertheless, in the final, the author emphasizes that the assumptions can be accurate because the actions of the main actors correspond to any of them, and therefore it is difficult to predict changes in the structure of the oil market and the world economy in general.
Possible Market Structure of the Global Oil Industry
The Current State of the Oil Market
Ghez’s case was written in 2016, and it analyzed the events in 2014-2015, but some changes have happened since then, which refute almost all the author’s assumptions. This statement can be inaccurate as little time has passed, but the current state of the oil market should be discussed to suggest future developments. The main features are a slight increase in oil prices, the actions of Saudi Arabia to reduce production, and the development of the US oil shale industry.
The first and most important feature is the change in the policy of Saudi Arabia and OPEC to reduce production. This move brought an increase in the cost of oil to $60, which is a noticeable, but not decisive increase (Krauss). This fact partially confirms the hypothesis of replacing oil with alternative energy sources, since as Figure 1 shows, prices are almost at the same level, which means low demand. The Kingdom has been the decisive member of OPEC for a long time, and the hegemon of the oil industry, so changes in OPEC policy are reflected in it in the first place (Genc 242; Claes 328). Thus, Ghez’s assumptions about the USA, Iran, and Russia are not confirmed, since these states do not feel adverse consequences of the oil crisis.
The United States continues to increase its oil shale production capacities, the demand on which only grows (Kim 1063). Russia began to dominate the creation of OPEC policy due to an increase in oil production (Lee). And although some states, such as Venezuela, have suffered significant losses, the results are still unsatisfactory for the Kingdom. Thus, these facts show that either Ghez’s hypothesis was not right, or Saudi Arabia’s policy was a failure in the first place.
Variations of a Market Structure According to Different Forecasts
If we assume that Ghez’s hypotheses that Saudi Arabia had been keeping low oil prices intentionally were correct, but such a policy played against it, then the market structure change only the main actors. The Kingdom currently tries to raise prices to save its profits from exports by reducing production even more than other OPEC countries (Krauss). At the same time, Russia is ahead of Saudi Arabia in production, and Iran is gradually increasing its capacity. The United States also holds a leading position in the production of crude and shale oil, and most of this industry belongs to private companies (Krauss).
Thus, if shortly, the demand for oil does not increase several times, then Saudi Arabia will be forced to give up its hegemonic place. OPEC countries will compete with the United States, and Russia can become the leading player, which can influence the formation of the organization’s policies and the participating countries. Therefore, the structure of the oil market will look like a competition between the US, OPEC countries, European states, and Russia, which will try to become a leader in the field.
However, if another Ghez’s hypothesis about the end of the oil era is correct, then the market itself will collapse, and another market will form based on alternative energy sources. At first, shale oil-exporting countries can create a new system, since its production is much cheaper. However, since oil and its production pollute the environment, the world can soon switch to renewable and environmentally friendly energy sources. Consequently, the leaders in the energy market will be the countries with the most advanced technologies that allow the generation and export of alternative energy. Thus, the very concepts of the world oil market will cease to exist.
The case study analyzes the oil market crisis that began in 2014 and the reasons for its occurrence. All the author’s assumptions are reasonable and logical; however, they are equivalent in their reliability, and it is difficult to guess which of them is more appropriate. Perhaps all forecasts are right for the short and long term, which means a change in the structure of the oil market, or rather its leaders in the coming years, and then a complete collapse of the oil industry due to lack of demand. Current pricing trends push for such assumptions, but so far, they do not have one hundred percent probability.
Claes, Dag Harald. The Politics Of Oil-Producer Cooperation. Routledge, 2019.
Genc, Talat. “OPEC and Demand Response to Crude Oil Prices.” Energy Economics, vol. 66, 2017. pp. 238–246.
Ghez, Jeremy. Oil: Betting on Prices after the Big Drop. HEC Paris, 2016.
Kim, Myung Suk. “Impacts of Supply and Demand Factors on Declining Oil Prices.” Energy, vol. 155, 2018. pp. 1059–1065.
Krauss, Clifford. “OPEC and Russia Agree to Cuts in Oil Production to Push Up Prices“. The New York Times. 2019. Web.
Lee, Julian. “Saudi Arabia’s Best Bet Is to Crash the Price of Oil.” The Washington Post. 2019. Web.