How Oil Prices Impact the Economy

free essayOil prices have fallen sharply in the past few months from 100 to 40 USD per barrel (“Crude Oil”). The decrease in oil price levels has revealed many of the problems of countries that are heavily dependent on oil revenues, such as Saudi Arabia, Iran, and Russia. There are numerous reasons for such a slump.

The most obvious cause of lower oil prices is the global economic crisis, which led to a decrease in demand for petroleum products. It also reduced growth rates in most countries, especially those of the European Union. An increase in the level of supply over demand also played a significant role in oil price collapse, especially with the entry of new countries into the oil market of Africa and South America. New oil discoveries of huge reserves forced the OPEC nations to decrease the oil extraction by about a third. Such a fact led to a decrease in the role of OPEC in pricing. Nonetheless, OPEC is still effective but its role has fallen in comparison with previous years. Moreover, a role of the market as a factor of price formation is constantly growing. Economic globalization is characterized by the opening of new markets and competition in general. Therefore, the energy prices began to be influenced by this competition because the OPEC members try to keep their markets, but it is not an easy thing to do due to the oil abundance.

Shale oil is another significant for oil prices decline. Manufacture of oil shale in the United States has turned it from the major oil consumer in the world to a self-sufficient country, which is ready to export oil to other market participants. Moreover, USA has become a model for other countries, which are now trying to find the natural oil reserves. In addition, oil theft and smuggling by ISIS and other terrorist organizations reduced oil prices even more by selling it at a lower price, which is much less than the market one. The gradual decline also comes as a result of the search for other energy sources, such as the nuclear energy or renewable energy sources. Finally, the continuing call for conservation and protection of environment reduces the use of polluting energy sources, which threaten human life by increasing the speed of global warming.

The Impact of Falling Oil Prices on Saudi Arabia

Saudi Arabia is one of the largest oil-producing countries in the world, the first-ranked country in OPEC, and one of the largest exporters in the world. Saudi Arabian oil has a relatively low cost of production. It is also the first in the world in the number of natural oil reserves.

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The state decided not to reduce oil production, which has caused a lot of criticism at the OPEC meeting 2015 (AFP). It was even accused of implementation of the US plan aimed at weakening Iran and Russia. Saudi Arabia tried to explain its decision by the fact that the oil price has become associated with the market’s supply and demand rather than with the countries.

In fact, the state’s decision not to shrink the oil extraction has multiple goals. For example, the country, perhaps, wants to reduce or even stop the production of shale oil. Saudi Arabia has a lot of money in hard currency and a low level of public debt. In fact it is currently the lowest debtor among the twenty countries in OPEC. Therefore, the Arab state can cease production of American shale oil through an oil prices drop to 30 USD per barrel, because it can withstand the losses caused by such a reduction. For example, it had a deficit in the general budget of about 50 billion USD in 2015 (AFP). However, Saudi Arabia can afford such a money shortage for a decade because of the vast reserves (AFP).

The Impact of Falling Oil Prices on Iran

Oil is the main source of income in Iran, although the country has economic, industrial, and agricultural industries (Solomon and Said). However, the country has been suffering from severe economic sanctions for many years, which had a negative impact on the oil industry and other sectors of the economy. It should be noted that Iran has been also experiencing negative effects from reduced domestic oil production for a long time. For example, it produced 3.58 million barrels per day in 2011, while the amount of oil produced in late 2014 was 2.77 million barrels per day (Khajehpour). Such a substantial slump can be explained by the lack of investment and difficulties in obtaining the necessary equipment to increase the production.

Currently, the decline in oil prices creates a strong pressure on the Islamic Republic of Iran and leads to a large reduction of investments in the energy sector. However, it is possible that it will not significantly affect the Iranian economy and policy in the region because Iran may start to develop other sectors of the economy over time. Sanctions have become a primary cause for the drop in oil production because the number of planned tasks and projects cannot be realized without the Western drilling techniques such as the Arctic shelf development. The increase of production using current sources of oil will not be possible because the old deposits are close to exhaustion.

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The Impact of Falling Oil Prices on Russia

Oil is the foundation of the Russian economy and the basis for playing an important role in international politics after the collapse of the Soviet Union. Oil revenues are a source of financing rearmament, as well as the main source of Russia’s budget. The Russian Federation is one of the most important oil-producing countries in the world, producing more than ten million barrels of oil per day. Russia loses approximately two million dollars if the oil price per barrel drops for at least one USD. Despite this, Russia has decided not to cut the oil production because it is afraid that other countries will take its place in the oil market by increasing their production (Agerton).

The country is experiencing a sharp fall in its national currency because of the reduction in the price of a barrel of oil. The Russian Federation exchanged their hard currency reserves in an attempt to keep the ruble from falling and to align the exchange rate. Currently, Russia is subject to the United States’ and the European Union’s economic sanctions. In spite of the oil price impact on the Russian economy, it has an industrial and economic potential as well as such raw material such as gas, gold, and so on (“Russia Analysis”). However, it is possible that lower oil prices will hinder Russia to return to the international arena as a major force, as it was in the Soviet era.

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Decline in Oil Prices and the Political and Economic Consequences

Is the decline in oil prices caused by supply and demand or is it a political and economic goal? Simply put, there is no economics without politics and no politics without economics. That being said, there is a clear connection between politics and economics, and Charles de Gaulle proved this point by stating that domestic capacity and foreign independence are two aspects of a single situation (Morse 118). From the economic point of view, it must be admitted that the recent discoveries of oil deposits in the world, as well as technological development of shale oil, largely contributed to the increase in supply over demand. As a result, the importance of OPEC in the world oil market fell. From the political point of view, the effects of low prices influenced many oil-producing countries, especially Iran, Russia, and Saudi Arabia.

The political consequences can be divided into external and internal ones. Internally, the decline in oil prices threatens the political stability within the countries because it will affect the price of social services the stability of these countries depends on. Externally, the fall in oil prices may affect the foreign policy of Iran and Russia. Perhaps, the impact of such influence will be insignificant in strategic matters, but it may represent a serious blow to the economic stability. As for Saudi Arabia, it will need to adopt a new economic policy that is not based on the income from oil production and develop it sustainably, as well as carry out multiply reforms in various sectors of the economy.

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Conclusion

Ultimately, one can say that Saudi Arabia is considered the most important player among the listed countries in terms of oil production. This role may become even more influential in this situation in the world oil market. Given the above, price of oil has become closely associated with the supply and demand on the market rather than the domestic situation of the exporting countries. The consequences of the decline in oil prices will affect Iran in the strongest way, and then there will be a significant impact on Russia, while Saudi Arabia will experience virtually no negative consequences at all because the degree of influence depends on the country’s budget.