The Power of Oil – OPEC Taking Control

Bouncing like a fracking crane, fluctuating oil prices are a constant feature of the modern market. There is little that is more important than oil prices, given that they affect so many industries and intrude into all nations. A major player in this phenomenon is the Organisation of the Petroleum Exporting Countries (OPEC), an intergovernmental organisation of 14 nations (Algeria, Angola, Ecuador, Gabon, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE and Venezuela). These nations account for an estimated 43% of global oil production, giving OPEC a major influence on global oil prices. Many of the involved nations are located in the Middle East, to which it is common knowledge that here is the centre of the world’s oil supply. It is estimated that the region holds more than 700 billion barrels of oil in its various fields.

On 30th November 2016, OPEC began flexing its muscles by agreeing to reduce output by 1.2 million barrels per day to 32.5 million; with nation Saudi Arabia (holding the most oil in the world) shouldering most of the commitment. The cut, which will begin from the New Year, will be accompanied by non-OPEC members, Russia, pledging to reduce their output by 600,000 barrels per day. As a result of this news, on the day following the deal, oil prices rose almost 9%.

If all is achieved, the total proposed cut of 1.8 million barrels per day would reduce nearly 2% off total global production. The cut, which is set to last 6 months, will see traders monitor oil-tanker traffic to ascertain whether fewer are leaving port. OPEC cannot, however, monitor Russia’s commitment because much of its production moves by pipeline – but surely Mr Putin is always good for his word?

Why are they doing this?

OPEC’s President, Mohammed Bin Saleh al-Sada, claimed that the cut had been agreed “for the general well-being and health of the world economy. This will help rebalance the market and reduce the stock overhang”. Two years ago, global oil prices crashed after the world started pumping out more crude oil than was needed. This drastic reduction in the price of oil severely affected the budget of many of these oil-exporting nations; such as Saudi Arabia losing billions in revenue. Now these oil producers have come together to reduce output to rectify the situation; many think that this deal will mark the beginning of the end of this two-year oversupply in the world’s oil markets.

What does it mean for consumers around the world?

Some nations will be affected more than others – logically, the world’s biggest economies use the most oil. America, with the biggest GDP, consumes more than any other nation – using 25% of the estimated 80 million barrels of oil produced around the world each day. Whilst the US is arguably set to suffer the most, it is undeniable that a host of other nations can be affected to a similar degree – but really, what could we be in for?

A rise in oil prices often means a rise in prices for businesses and consumers alike. First and foremost, the deal with be bad for consumers’ direct use; being forced to pay more to fill their cars. Many industries suffer, with businesses incurring costs due to the use of oil in methods of manufacturing and transporting. As these businesses incur the higher costs, these are passed on to the consumers so as to retain profitability and sustain cost payments. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food. Additionally, the cost of materials that are made from oil, such as asphalt and chemical products, also rises. If the cost of oil rises, it tends to raise the cost of other fossil fuels. The cost of natural gas extraction tends to rise, since oil is used in natural gas drilling and in transporting water for fracking.

Notably, as the oil market is constantly fluctuating, salaries do not rise in line with the rise in oil prices. As a result, when oil prices rise, and such prices are passed to consumers, there is little room for discretionary spending; people need to save the money for basics such as food and petrol. This lack of discretionary spending affects industries of the economy, especially those relating to such markets as holiday travel and restaurant eating. In a circular phenomenon, many of those businesses then have to find ways to reduce their own costs, and many struggle to sustain their business.

Theresa May last week said that Brexit keeps her up at night, this is just another thing to add to the list. With the uncertainty of the economy post-Brexit, the Prime Minister wants an encouragement of spending in the economy, rather than have prices pushed up further and consumers shy away from spending. We have already heard the concerns of rising inflation, as Brexit caused the pound to drop, meaning many businesses were forced to pay more to import materials, therefore needing to push prices onto the consumer. Now, if businesses requiring the use of oil are having to pay more in this regard, could further increases in prices be passed onto the consumer, creating the possibility of even higher inflation over the course of the next year?

Aforementioned, given that the reduction is set to last 6 months, it will be interesting to see what the price of oil will stabilise at, and whether it really will have a drastic effect on product / service pricing. 2016 has been bad enough in many respects, hopefully this deal does not line us up for a miserable 2017 consisting of higher prices all round – firstly because I don’t want out-of-pocket expenses, but secondly,  as a Manchester United fan, I can’t stand the thought of any joy coming to Roman Abramovich and his oil ventures.

 

By Dre Efthymiou

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