- The Washington Times - Thursday, March 24, 2016

Global oil prices are projected to scrape along at $40 a barrel or less through 2016, continuing to hammer economies in Saudi Arabia, Russia and other nations — and thus altering global politics — despite the producers’ efforts to limit output and counter the slump.

A financial intelligence report by the European banking giant Societe Generale forecasts that global oversupply of oil will remain “stubbornly persistent” despite steady growth in demand driven by the U.S. and emerging markets, including China.

The market imbalance is proving a boon for energy-dependent economies while wrecking the budgets and trimming the ambitions of countries accustomed to wielding oil and gas riches as key leverage in foreign policy.

“The fundamental picture after all remains weak,” German financial giant Commerzbank said in a note to clients this week, The Wall Street Journal reported. “There are no viable arguments on the oil market for price rises.”

Michael Wittner, who heads Societe Generale’s New York operations, said in an interview that if the Saudis and Russians agree to freeze output — something expected at a major summit of OPEC and non-OPEC producers April 17 in Doha, Qatar — it won’t “mean a darn thing as far as real supply in the global market.”

The reason, he said, is twofold. First, Saudi Arabia and Russia, which stand a close second and third behind the U.S. on the world’s list of top oil producers, are talking about only “freezing” output at January production levels rather than making real cuts.

Second, any impact from the freeze is expected to be offset by Iran, whose leaders have scoffed at the idea of a freeze as they scramble to re-enter the global market now that a nuclear accord has eased international sanctions.

Mr. Wittner also pointed to a wild card in every projection: China. He said China’s growth in oil consumption remains healthy but its slumping economy is raising concerns about a hard landing in the coming year that would weaken demand in a flooded global market.

But even as uncertainty hangs on China’s economy, the Societe Generale report published last week predicted that oil prices are on track for a long-term recovery to the $75-a-barrel range by 2020 because of growing demand from the developing world — particularly India, the Middle East and Africa.

“The bottom line is that low-cost Mideast crude oil and medium-cost U.S. shale oil just won’t be enough to meet global demand expansion in the longer term,” said Mr. Wittner. “We think prices will recover next year to $50 and, as the markets start to eventually get rid of this global oversupply, then we start to head back to a $75 world by 2020.”

Saudi miscalculation?

The plunge in oil from roughly $100 a barrel in mid-2014 to less than $40 — where prices have hovered since late last year — has largely been pinned to a strategic gamble by Saudi Arabia.

As prices began to plummet, Riyadh kept Saudi output high on the hope that a flooded global market would eventually undercut higher-cost producers, in particular a new generation of American shale-oil fracking companies and offshore drillers.

Such newfangled, higher-cost production methods rely on elevated prices to justify drilling investments and to ensure an acceptable level of profit.

If prices dropped low enough, the logic went, the non-OPEC sources would get squeezed out of the market, the glut from overproduction would dry up and the cost of crude would soar back to above $100 a barrel — with the Saudis in a great position to cash in on their bet.

A Peterson Institute for International Economics study published this month suggested that the Saudi strategy has worked — to a degree. “The plunge in crude oil prices has hurt oil producers and dampened investment in drilling activity in the United States,” said the study. “Energy-related enterprises are under increasing financial pressure, raising questions about the financial soundness of banks and others who have lent them money.”

The problem, according to other analysts, is that the gambit is taking considerably longer than Riyadh had banked on, in large part because U.S. producers have shown a surprising ability to stay in the market even with prices in the $30-a-barrel range.

“One of the remarkable features of last year’s oil market was the resilience of American shale producers in the face of falling prices,” the Economist magazine wrote recently. “Since mid-2015, shale firms have cut more than 400,000 [barrels a day] from output in response to lower prices. Nevertheless, America still increased oil production more than any other country in the year as a whole.”

Riyadh also appears to have made a bad bet against the nuclear accord that the U.S. and five international partners struck last summer with Iran, which is now poised to flood the market with crude that was taken off the market in 2012 because of sanctions.

Impact on the U.S.

The Iranian factor aside, most analysts say the U.S. now holds a stronger overall position in global energy markets than it has in decades.

The nation continues to import roughly 30 percent of its oil, but U.S. domestic production has surged by some 80 percent since 2008. Many believe the production has immunized Americans from global volatility to a degree that seemed inconceivable just a decade ago.

“The massive increase in U.S. oil production over the past 10 years has been phenomenal,” said Timothy Adams, president and CEO at the Institute of International Finance, a global trade analysis group based in Washington.

In testimony this month before the Senate Committee on Foreign Relations, Mr. Adams said the situation “gives us enormous independence” in comparison with the 1980s and 1990s, when “we were seen as having diminishing capacity to produce oil.”

At the same time, lower oil prices and cheaper gasoline are boosting the U.S. economy as consumers spend dollars saved at the pump on other goods and services, investments and personal debt reduction.

That also goes for several U.S. allies, Mr. Adams said.

Falling oil prices, he said, are “like a massive tax cut” for Europe and Japan, as well as emerging markets such as India, Indonesia and Turkey.

But the macroeconomic benefit is double-edged. Many financial analysts say the boost to consumers’ wallets has been largely offset by a 40 percent drop in capital expenditure in the oil and gas sector.

Geopolitical instability

If oil prices stay low for too long, the biggest danger for the U.S. centers on geopolitical volatility, such as political instability in Nigeria and Venezuela and unpredictable reactions from Russia and the Persian Gulf monarchies.

“Political impact is likely to be strongest among countries, especially in the Persian Gulf, that have invested billions in social programs and subsidies to discourage Arab Spring-like protests,” said former CIA Deputy Director John E. McLaughlin.

“In Russia, which needs oil prices north of $100 per barrel to meet its budget projections, the time-honored response to economic hardship is to mobilize nationalist sentiment with foreign adventures,” Mr. McLaughlin told Politico in January.

President Vladimir Putin escalated military activity in Syria just as the Russian economy and treasury were struggling to deal with the declining prices of oil, by far the country’s most lucrative export.

Others say the highest immediate risk of instability is in Latin America and Africa.

Fears are surging in Nigeria, the world’s sixth-largest oil exporter, where sustained low oil prices could trigger widening unrest and hamper the government’s ability to finance its campaign against the surging Islamic State-linked terrorist group Boko Haram.

Venezuela, whose oil and gas account for roughly 25 percent of gross domestic product, faces the prospect of all-out economic collapse.

Caracas is already dealing with the political earthquake that took hold after the 2013 death of President Hugo Chavez, who rode the wave of high oil prices during the 2000s to underwrite a socialist revolution. Mr. Chavez’s hand-picked successor, Nicolas Maduro, faces a national assembly overwhelmingly dominated by opposition parties after national elections in December.

“Of all the countries that are at risk, this is the one we need to be the most focused on right now, because Venezuela is an economy on the edge,” said Robert Kahn, a senior fellow for international economics at the Council on Foreign Relations.

Mr. Kahn, who testified alongside Mr. Adams before the Senate committee this month, warned that Venezuela is “descending into a deep and profound crisis, reflected in the severe shortages, hyperinflation and a collapse in economic activity.”

Venezuelan default on foreign debt along with “the chaos that would come after [it] is a question not of if, but when,” Mr. Kahn said.

“Low energy prices are going to continue to generate global risks,” Mr. Kahn said. “We need to be thinking ahead and ready to act when the opportunity presents itself.”

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