What is Fueling the Price of Oil? (1/2)

December 4, 2014

The Russian ruble takes a tumble as the falling oil prices slide, Dr. Thomas O'Donnell discusses the geo-politics of it all



Story Transcript


The recent decision by the Organization of Petroleum Exporting Countries, OPEC, to leave collective output unchanged has resulted in a major drop in oil prices. Beyond cheaper oil costs at the gas pump, what significant geopolitical effects can be expected? One implication is that the Russian ruble experienced its greatest one-day drop in value since 1998.

What will happen to the economy of oil-dependent Venezuela?

Now joining us from Berlin, Germany, to discuss these issues is Dr. Thomas O’Donnell. Dr. Thomas O’Donnell is an expert in political economy and geopolitics of the global energy sector, especially petroleum. He’s currently at the Free University of Berlin.

And, Thomas, I want to welcome you to The Real News Network.

DR. TOM O’DONNELL: Thank you very much, Sharmini. I appreciate the invitation and the opportunity to speak with you.

PERIES: Tom, you write and lecture on geopolitics of oil and, as you call it, the market-centered collective oil security system. Can you break down for us the players besides OPEC’s, such as the International Energy Agency and the International Energy Forum and what role these super state organizations play?

O’DONNELL: Yes. We have to–to understand the role, we have to go back. And the best way, I think, to look at it is to look at it in contrast to what existed before the OPEC revolution in the 1970s. By that I mean when OPEC states took control of their own oil, nationalized their oil.

Before that, we had the Seven Sisters international private oil companies that controlled everything. And there was no market. They own the oil in the producing countries, yhey own the gas stations, and they on the whole pipeline and production facilities in between. And they set the price of oil without a market.

When OPEC nationalized their oil, that undermined that market model, you could say, the model of those companies. And what happens then is, what evolved over the next decade or so was an open market, where OPEC producers and other producers as well, could sell their oil to the highest bidder, to all comers.

However, there’s still the problem of all sorts of volatility and mistrust and various problems. And so, on the two sides, the Global North organized the countries of the OECD, that is to say, the First World countries, organized the International Energy Agency that represented their interests in confrontation with OPEC, which represented the interests of the producing countries. And over time became the various agreements and understandings, one of the other, that within limits, at least, it’s in both sides’ interest to try and keep the market fairly stable, so that there weren’t big disruptions when there’s a war or when there’s a natural disaster. So in a nutshell that’s what those super state organizations do. It was a free market. But it is controlled, and there are certain limits on it imposed, exercised by these organizations.

PERIES: So, then, what role does the United States and Europe play in this configuration?

O’DONNELL: Well, the United States was really the driving force in founding, for example, the International Energy Agency, which essentially represents the First World countries, but it’s actually broader than that nowadays.

You see, in the system that existed previously, there was these bilateral dependencies. If the Iranians nationalized their oil, which they did try to do in the 1950s, British Petroleum got most of their oil from there, and that meant that Britain had a severe problem in receiving oil. But it wasn’t particularly a problem for France or Italy or the United States. And similarly, the big companies that were based in the United States were perhaps in Saudi Arabia or in Venezuela. So there are these bilateral relationships. And if some country lost their oil, this bilateral relationship, it tended to cause conflicts between even the First World countries.

The present system that’s mediated by a market–I like to talk about the market as sort of virtual one global barrel. All the producers essentially sell their oil to that market, that is to say, dump their oil in that one barrel. And it’s all traded in dollars across the world. That’s more or less for one price. And all consumers take out of that barrel. That means that there’s–these bilateral relationships or dependencies are essentially eliminated. What happens if Algeria, say, goes offline? No longer is France in severe trouble; they just buy–it just lowers the barrel and raises the amount of oil in the barrel and raises the price for everybody and encourages others to produce more oil and put it in. So in a certain way it avoids certain types of conflicts, geopolitical conflicts, that existed previously. There are other types of conflicts that come up, of course.

PERIES: And since the currency that oil is traded in is still predominantly the U.S. dollar, does that give the United States an economic advantage, say, over China and Russia and other oil-producing countries?

O’DONNELL: To a certain amount it does, of course. In a way, the United States is very much at the center of this system, as is Saudi Arabia also on the other side. But in the entire world financial system, of course, the fact that the dollar is the medium through which almost everything else is traded does give the United States a very central position.

Now, let me just make a sort of a concrete example. This is a system where generally the United States protects the right; the foreign policy, more modern foreign-policy, as long as the system has existed, more or less protects the right of every country to participate in this market system. However, if there’s some country that’s seen to not be playing by the rules, such as Iran over the last couple of decades, they could be excluded from this system. So since there’s really this very clearly centralized market-centered system, they were–because sanctions were put on Iran, they’re not–and also sanctions lately have been put on their ability to do any transactions in dollars–they’re essentially excluded, largely excluded from this system. And so that’s something, a way in which, for example, the United States and their allies can use the system to their own geopolitical interests.

PERIES: Right. And explain to us why the ruble took a tumble with 70 percent of Russia’s exports being oil and gas, accounting for half of their government’s funding. This has some serious implications. So explain why that happened.

O’DONNELL: Well, I mean, put it this way. If you were General Motors or some or Volkswagen and suddenly for some reason the price of your cars just went down 20, 30, 40 percent, the value of your stock would go down as well, right? So, essentially that’s what’s happened in Russia. Their income is going–even if they continue to pump the same amount of oil, their income, which, as you said, is the majority of the income of the state is from higher hydrocarbon sales, is going to go down in direct proportion. And so confidence in the ruble goes down and the value of the ruble against other currencies goes down.

PERIES: And one of the things that perplexes people is if OPEC is going to do what they said they’re going to do, which is to maintain their production levels, how come the prices fell?

O’DONNELL: Okay. This is–at different periods, when the price goes up and down, you have to look at the particulars. This is sort of a perfect storm of lower prices.

One would have thought earlier this year, with all the geopolitical problems the Middle East, everything from Iran being under sanctions and exporting only a fraction of the oil they normally would, Libya, similarly, with the civil war taking place and then ISIS causing all sorts of disruption in Iraq, with that geopolitical impact and uncertainty, normally the price of oil would have risen considerably. But it really didn’t. And that reflected some realities of the market underneath, some market fundamentals on the one hand, and some structural changes that have taken place, which I’ll get to.

So, in the market, the thing is not only that there’s plenty of oil being produced now. Aside from OPEC, the United States over the last couple of years–well, I should say, about the last six or seven years, is producing something like 3 million more barrels a day than it did previously, and all of that is that basically all of that is due to fracking. And that amount of–that completely replaces, up till now, all the oil that’s been taken off the market in the Middle East and more. So there wasn’t that–on the supply side, there was plenty of oil coming into the market.

On the other hand, on the demand side–that would be enough to lower prices or moderate prices. But on the other side, you have contraction in China–it’s only the American economy that’s somewhat increasing its output. So you have lower demand in the world, higher supply. It’s just market fundamentals are that the price is going to go down and the capacity for the United States to expand production due to fracking, but other things as well, other ways of producing oil as well.

It was clear to OPEC that normally what they would do is cut their production and force the price up somewhat and maintain a certain price that they wanted to maintain. But the argument of the Saudi minister, Al-Naimi and others, was that there’s so much oil in the market and so little demand, they would have to cut so much oil to have an effect on the price that they would end up with only a tiny share of the market. So, instead of following that sort of traditional strategy, what they’re doing is they’re going to keep producing, and at the level they are, and let the price of oil drop and see where it stops, and try to stabilize it at some other point, lower point.

At that point, their oil is much cheaper to produce than the new oil in the United States. So they hope they’re going to get a much larger share of the market, although at a lower price.

PERIES: Right. Dr. O’Donnell, we would really like to continue this discussion in a second segment with you, if you’re willing to join us.

O’DONNELL: Absolutely.


