The current global oil market is facing a high increase in supply, which is creating problems for nations that rely on oil exports for their government spending. This is a problem for Russia, as the country has depended on high oil prices to prop up the economy and allow for generous government spending. The problem lies in the global increase in production of oil, as technologies such as hydraulic fracking have dramatically increased production in previously oil importing nations. The United States is an example of this, as the country has risen to become the top global oil producer. This trend has created a problem of oversupply in the global oil market and has led to a sharp decrease in oil prices and subsequent revenue from the sale of oil. Russia’s economy is placed under scrutiny due to this situation, as the country must rely on reserves as a means of filling the gap in revenue in order to maintain a consistent level of expenditures.
Above is the graph of the global oil supply market. The rightward shift in supply the supply curve indicates that when there is a higher level of supply, there is a lower market price for whatever good is on the market. This creates low demand and subsequently puts downward pressure on the price as suppliers can no longer set the price due to high demand. In regular economic theory, the low price would shift the supply curve to the left, as the price removes incentive for producers to maintain a surplus in the market. However, the global oil market does not function in a free market but is more similar to an oligopoly, as the market consists of independent countries and collusion on part of producing nations within the OPEC bloc. As there is no signal in drop in supply within the market, the price decreases.
Much of the considerations within this case are heavily influenced by political behavior rather than economic benefit. The OPEC bloc is seeking to drop oil prices as a way of punishing new producers on the market, as technologies such as hydraulic fracking require a higher price than traditional drilling to break even. As such, the strategy by OPEC is to lower long-term supply in the market by driving producers out of the market, as the OPEC breakeven price is much lower. In such a case, the predatory pricing strategy is used as a means of obtaining long-term market share despite the short-term costs of a drop in oil prices. While of questionable effectiveness in the long-term, it is causing problems for countries that have a high production volume and have depended on the volume for economic stability; low oil prices place certain economies into jeopardy, as it is no longer a source of export revenue.
One potential solution for Russia is to cut down on oil production due to the low price that current volumes are able to achieve. Although this would cause short-term pains to oil producers and decrease government revenues, it would significantly drop the availability of oil on the market. As such, prices would rise. The OPEC bloc cannot maintain low prices and high production for long, as it is causing deficit spending in all oil revenue dependent nations in the bloc. This maneuver would create higher oil prices and allow for a slow reintroduction of volume to the market; furthermore, this may cause a flurry of speculation in the market by introducing instability to supply, and as a result, would increase prices further.
While a potential solution, it is not without its consequences. The Russian government cannot afford low oil prices for long, as the government budget heavily depends on these export earnings for revenue. As such, a decrease in production combined with low prices may cause further damage than if high production volume was maintained. There is also the question of whether Russia maintains a sufficient enough production volume to shift global demand, as only critical suppliers to the market are able to cause such large shifts in pricing. Although Russia is a top oil producing nation, the introduction of producers such as the United States have made Russian oil much less important to the global market.