Crude oil is one of the commodities, which have a rare power to influence the global market substantially. Some economists suggest that “the rule of thumb is that a 10% fall in oil prices boosts growth by 0.1-0.5 percentage points” (“Who’s afraid of cheap oil?”, 2016). Bloomberg shows that the WTI Crude Oil is currently traded at 44.62 USD, which makes for an approximately a 60 percent drop since 2014. Thus, the rule of thumb suggests that the global economy should be growing at least at the rate of three percentage points due to the recent oil prices fall; however, is it the case? In this paper, I will discuss the impact of low oil prices on the global economy, the causes of recent crude oil fluctuations, and stress its impact on Russia, one of the world’s largest oil and natural gas exporters.
Though the issue of falling crude oil prices might seem complex, it boils down to the simplest economics of supply and demand.
Supply side. There are several supply-side factors that have significantly contributed to the oil price fluctuation.
First, an increased domestic production of the United States. Some time ago, the country’s immense demand had to be supplied by Nigerian, Saudi, and Algerian exporters. However, since the U.S domestic production of oil has almost doubled in the last several years, the country’s former suppliers have to search for new markets. Krauss (2016) suggests that these countries are now competing for Asian markets, which forces them to drop prices.
Second, some countries’ increasing production volumes. Krauss (2016) informs that Canadian and Iraqi oil producers have constantly been increasing their production volumes for the past several years. In addition, despite Russia’s immense economic problems, the country still has to keep up with other countries’ pumping volumes, as oil and natural gas revenues constitute a significant fraction of its revenue streams (Andrianova & Khrennikova, 2016).
On the other hand, recent increases in the oil price can be attributed to the temporary production shocks. Krauss (2016) informs that “rebel attacks in Nigeria have also curtailed supplies in that region, and the continuing fighting in Libya has stymied efforts to get that country’s oil industry back on its feet” (para. 10).
Demand side. The nature of low oil prices is not grounded in the supply only. Consumers’ preferences have evolved and they demand less oil. The research (Farber, 2016) shows a bolder outlook for the U.S. electric-car adoption rate than expected. It suggests that electric vehicles should constitute more than 35 percent of the U.S. market by 2035. Once it happens, the U.S. oil demand will drop from nine million to two million barrels per day (Farber, 2016). This trend is not happening in the U.S. only; rather, it is a massive global shift, which will have a substantial impact on oil producers and large oil-dependent economies.
The impact of cheap oil on the Russian economy. Russia is one of the world’s largest exporters of crude oil and natural gas. However, the country is also very dependent on oil revenues, as they constitute approximately 50 percent of its fiscal revenue (Andrianova & Khrennikova, 2016). Thus, the recent drop in oil prices has become a major blow to the country’s economic stability and performance.
In 2015, Russia ran a budget deficit of 2.6 percent, the highest value in five years. Furthermore, “this year’s budget was initially planned around oil averaging $50 a barrel and a deficit of 3 percent of gross domestic product” (Andrianova & Khrennikova, 2016).
The publication by Ekaterina Grushevenko (2015) provides a thorough analysis of the effect of lower prices on the Russian economy. In 2015, the Russian Ministry of Economic Development suggested that the country’s annual gross domestic product could contract by 4 to 5 percent if oil prices remained in the range 45 to 55 USD per barrel (Grushevenko, 2015). Furthermore, the Energy Research Institute of the Russian Academy of Sciences has suggested that the country’s economic growth will remain negative, around 0.5 to 1.5 percent, even if oil prices rise to 80 USD per barrel (Grushevenko, 2015). Grushevenko (2015) suggests that the price of 90 USD per barrel of oil is critical to the Russian economy, as it marks a bare minimum the country needs to achieve positive growth.
The impact of lower oil prices is not limited to Russia. Rather, it is a global issue, which has significant implications both in a long-run and a short-run.
First, low oil prices might offset political and social instability. The Economist suggests that “collapsing revenues could bring political instability to fragile parts of the world, such as Venezuela and the Gulf, and fuel rivalries in the Middle East” (” Who’s afraid of cheap oil?”, 2016). Just as in the case of Russian Federation, some countries depend too much on expensive oil to balance their budgets. For example, Libya, Iran, and Algeria need 184 USD, 131 USD, and 131 USD per barrel of oil respectively to meet their expenditures (Bowler, 2016). Thus, once governments do not have enough money, they might be tempted to cut on some social projects, which is a sensitive issue in world’s poor regions.
Second, the net long-term benefit of cheap oil is negative for China. While China is likely to benefit from low prices, as it is the world’s largest net importer of oil, the wider, long-term macroeconomic effects, such as weaker global demand, are likely to offset the positive impact of cheap oil.
In conclusion, the objective of this paper is to investigate the economic causes of lower oil prices and its effect on the global economy. Contemporary oil price fluctuation can be explained via the framework of the basic economic theory of supply and demand. Supply-side factors cause countries to flood the market with oil and, thus, drive its price down. On the other hand, consumers’ shift to electric vehicles is a significant push factor on the demand side. Overall, weaker demand and greater supply are responsible for the 60 percent oil prices drop since 2014. While some economists believe that cheaper oil can lead to greater rates of global economic growth, the analysis shows that its net impact is negative for the majority of global economies.
- Andrianova, A. & Khrennikova, D. (2016). How Cheap Oil Is Squeezing Russia’s Economy. Bloomberg. Retrieved 15 November 2016, from http://www.bloomberg.com/news/articles/2016-01-26/how-cheap-oil-is-squeezing-russia-s-economy
- Farber, M. (2016). This Is What Electric Cars Will Do To U.S. Gas Demand. Fortune. Retrieved 15 November 2016, from http://fortune.com/2016/06/20/us-electric-cards-gas-demand/
- Krauss, C. (2016). Oil Prices: What’s Behind the Volatility? Simple Economics. NY Times. Retrieved 15 November 2016, from http://www.nytimes.com/interactive/2016/business/energy-environment/oil-prices.html
- Grushevenko, E. (2015). The Effects of Lower Oil Prices on Russia. The National Bureau Of Asian Research. Retrieved from http://nbr.org/research/activity.aspx?id=561
- Who’s afraid of cheap oil? (2016). The Economist. Retrieved 15 November 2016, from http://www.economist.com/news/leaders/21688854-low-energy-prices-ought-be-shot-arm-economy-think-again-whos-afraid-cheap