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Declining Crude Prices: A General Overview of the Effects

Despite OPEC’s decision in November to keep production constant at 30m barrels a day, output did fall marginally by 122,000 barrels or 0.4% in December, 2014. The price of the WTI and Brent standard stood at $51.96 and $55.78 respectively at 9:25 pm on January 4th, 2015. All this follows in the wake of oil prices decreasing during 2014. The effects of this decrease have reverberated in global markets around the world, and governments have responded in different ways.

Asian Economies: Ulterior Motives

The decline in the price of crude oil over the past three months has affected countries very differently. For instance, Indonesia, an emerging economy that used to be a member of OPEC, but then suspended its membership in 2009 in the wake of increasing internal demand and declining production of petroleum, implemented additional measures to reduce subsidies following their November announcement to limit diesel subsidies. As per the latest announcement, the government has stopped subsidizing gasoline, and has implemented a fixed diesel subsidy of $0.08 as of the first day of 2015 instead. Similarly, India’s now eight-month old government announced reductions of diesel subsidies in October. These governments have reduced subsidies due to lower crude prices, which have ensured that consumers no longer need to be shielded as strongly from previously high fuel costs. Additionally, India is expected to reduce its current account deficit through these means under the Modi administration. However, this scenario of limiting subsidies and utilizing lowered fuel prices to help the government’s checkbooks along is the not the case in the rest of the world.

 

Russia: More Harm than Good

In contrast to India, Russia, another emerging economy, is on the other end of the spectrum. As one of the largest producers of crude in the world, the country’s economy is heavily reliant on the oil and gas industry. In the first half of 2014, around $173.4 billion out of the $255 billion export-based slice of Russia’s GDP was sourced from sales of oil and gas. Due to falling oil prices, by 7 October 2014, the rouble closed at 39.9462 and depreciated sharply to 58.75 by 2 January, 2015. The fall in the value of the rouble has resulted in annual inflation for 2014 rising to 11.4%. As a result, in mid-December, Russia’s central bank decided to raise interest rates to 17% from 10.5% to fight inflation. This would later result in an influx of foreign investment inflows due to the high anticipated rate of returns.

 

North America: Bad News for Energy Source Producers, Good News for Consumers

Across the Atlantic, there is much evidence to show that Canada would feel the effects of the decline in oil prices. A report prepared by Bank of Montreal shows that the Canadian Energy Industry would be affected negatively due to the decline in crude oil prices, while consumers would benefit from lower gas prices.

Jim Prentice, the premier of the province of Alberta, predicts that a drop in the price of crude oil by C$1 would result in a C$215 million decrease in revenue for the province. According to the chief economist of ATB Financial, Todd Hirsch, 11,000 jobs were lost in the month of November in Alberta. Hirsch states that losses occurred in the “professional, scientific and technical occupations” which were related to the local oil industry. A report by the Conference Board of Canada in 2012 forecast the oil sands to generate $79.4 billion in federal and provincial revenues between the years 2012 – 2035. This forecast can now be expected to be an overestimate, as BMO’s chief economist estimates that the decline in oil prices could lead to a 25% reduction in Canada’s trade surplus. Additionally, Joe Oliver has now forecast the trade surplus at C$6.4 billion for the fiscal year 2015-2016. These bearish estimates follow a strong performance by the Canadian economy, with the GDP growing by 2.8% and beating estimates of 2.1%, in 2014. According to Statistics Canada, oil exports increased by 2.2% in the third quarter of the year – 2014-2015 when compared with second quarter results. For now, it remains to be seen how Canadian, and provincial, economies will fare in the wake of declining prices.

The shale industry has also felt the heat, with America expected to be most affected of all national shale markets in response to decreasing crude prices, as its output makes up 3.7% of the global output of shale oil. According to The Economist, the output of shale oil wells falls by 60-70% in their first year, meaning that they can only last a couple of years at most. In order to sustain output, new wells need to be discovered and dug. However, the break-even cost for the production of oil from shale wells is estimated to be $65-$70, according to consulting firm Wood Mackenzie. Additional drilling and development costs brings this figure up even higher, making the break-even point even more unattainable for firms.

Wood Mackenzie also estimates that the amount of investment in the discovery of new wells could decrease by a half, should oil prices remain at $60 a barrel. Saudi Arabia stands to benefit from this, as such a low price would force several producers out of the market. The exit of several other firms in this field would kickstart a cycle of rising prices, thus benefiting Saudi Arabia in the long-run. The decision to maintain the OPEC’s output was described as a “strategic mistake” by Iran’s deputy foreign minister, Hossein Amir Abdollahian. Venezuela and Algeria were also in favour of a cut. This begs the question: was this “strategic mistake” implemented in favour of Saudi Arabia, and done at the expense of other producers, in order to initiate a competitor elimination process?

 

Bringing the Issue Back Home

For Canada, a good indicator highlighting the effects of the fall will be the results of the fourth quarter. Figures given by StatsCan show that the main industrial sectors contributed 0.438% to the growth in the country’s GDP. Mining, oil and gas extraction alone made up 0.215% of this change. The same report also cited exports and domestic consumption as the reasons behind Canada’s strong economic performance this past year.

In the future, the Canadian economy might not be able to rely on its energy sector. There are reports suggesting that the Chinese economy, a major consumer of Canadian oil, is slowing down. Additionally, the Organization for Economic Cooperation and Development predicts that the Central Bank might raise interest rates in May of this year in an attempt to lower inflation to target rate of 2%. Bearing all this in mind, it suffices to say that the Canadian economy faces some stumbling blocks this coming year, just like many other countries, following the decline in crude oil prices. 

 

Varun Fotedar is a first year student in Rotman Commerce, at the University of Toronto.

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Harrison Lee is a first-year student in Rotman Commerce, studying economics. He is a former intern at the National Review, as well as a former resident of Taiwan and Vancouver, and is currently serving as corporate liaisons director, as well as a Public Policy & Society columnist at The Foreign Observer.

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