February 25, 2016    3 minute read

The Oil Crisis in a Nutshell

   February 25, 2016    3 minute read

The Oil Crisis in a Nutshell

“Oil wealth has been a curse on us, made us weak and docile.”

Abu Bakar Bashir

The second half of the 20th century has been marked by the domination of OPEC (Organisation of the Petroleum Exporting Countries) on the oil market. This oligopolistic organisation includes twelve countries predominantly located in the Middle East and Africa. For several decades, it was able to control the oil price by playing with the supply volume. However, in the last few years, other producers are arising within the market such as the USA, Russia, or even China (which is supporting some poor African countries and then importing their petroleum cheaply). This led to an increase in supply and thus intensified the competition within the market.

It’s important to remember that there are three main factors impacting the oil price: the importance of oil in businesses and consumer activities, the oligopolistic configuration, and the geopolitical situation. More recently, a fourth driver has been distinguished, lying in the development of alternative energy as a reaction to ecological concerns.

The starting point of the current oil crisis began in 2014 with two main factors: on the one hand the increase in American and Canadian oil production, and on the other hand the decrease in demand from traditional substantial consumers (China, India, and Brazil). In the past, OPEC used to cut the production to be able to raise prices. Nevertheless, as the competition heightened, the organisation decided to increase its supply in order to ruin the American upsurge. This triggered the beginning of a commodity battle.

In quite a year, oil prices decreased by more than 70% leading to a market crush, which looks interminable. As a matter of fact, the production level achieved a step where the supply is superior to the demand, which is unheard of! The oil market even reached a point where business is becoming quite unprofitable.

This situation is affecting the producers but also governments, firms, and individuals. Indeed, many local economies are resting on the oil business: while Nigeria and Angola required support from the World Bank, such countries such as Saudi Arabia, Russia, or Venezuela are facing economic difficulties. In other producing countries such as Kazakhstan, this situation had a direct and destroying effect on the currency, which hindered the local purchasing power. Moreover, oil companies achieved a stage at which they have no other choices than laying off and cutting investment. This price drop could partially benefit to consumers but, as most economies are facing a decline in their currency, it, in the end, boils down to the same thing. Besides, many consuming countries are also producers (‘prosumers’).

Recently, however, an agreement between Saudi, Russia, Qatar, and Venezuela had been reached, implying a production freeze. However, one may question the sustainability of the agreement as most of these economies are dependent on the oil business. Additionally, some producers such as Iran don’t seem to be ready to play the game and accept an agreement. This occurrence underlines the importance of geopolitics within the industry.

It appears that three issues result from the oil crisis. First we can wonder if the OPEC will succeed regaining its position of power. Second, we could question if producers could achieve an agreement or if they will play a tug of war until new leaders appear. Finally, we can also address the case of renewable energies in our economies and if they constitute a real threat to the oil market.

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