Oil: The Drop Felt Round the World
WHY YOU SHOULD CARE
Because oil gushes and gluts can have effects that are far from slick.
Let the good times roll, right? The West is reveling in cheaper gas and America’s flying so high — thanks in part to the shale revolution — that it’s telling the world to stop riding its coattails. But remember, what goes around, comes around: Booms here mean busts there, and it can all come back to bite us in the arse.
Indeed, the U.S. economic boom, mixed with tenuous relations between the Ukraine and Russia as well as the rise of ISIS, has western leaders sniffing for winds of change. So while many of us are enjoying saving dollars at the pump now, the question is at what cost tomorrow?
Here’s how the drop in the price of oil has already tipped a line of dominoes globally — and what could happen if there’s a prolonged downturn.
Slipping Up Terror
First, some good news: Cheaper oil has pushed down the black market price for oil offered by ISIS, which relies primarily on extortion and stolen resource sales to fund its activities. In fact, oil production in ISIS-controlled areas has plummeted, thanks to their own mismanagement and allied bombings. Another issue at play: the wartime economy’s hyper-inflation, which drives up costs for tools needed to make oil flow. Meanwhile, folks won’t show up to pump or ship the oil if the terrorists cap too much of the revenue. So, for ISIS, that “value has to have gone way down,” says Jacob Shapiro, an international affairs professor at Princeton.
How much of a plus is the oil boom in America and bust worldwide in the fight against ISIS? Incoming CIA Deputy Directory David Cohen estimates that the terrorists’ oil revenues have dropped from around $1 million a day to a couple million a week. To remain politically competitive, experts say, ISIS must either do more for the people it governs, downsize, boost taxes or fail to deliver on the services promised. (Sounds like most governments, right?) Any of these outcomes would signal a deterioration of the militants’ cohesion.
Meanwhile, ISIS’ threat to Iraqi production is upping the ante for other world players to get involved. Beijing, for one, is heavily invested in Iraqi oil and has offered to support anti-ISIS efforts.
Collapsing oil prices and western sanctions are also painful for Moscow. But if you’re holding your breath for reform, you may pass out. The Kremlin is feeling the pinch because, as Michigan State University finance professor Andrei Simonov says, “there is big dependence for the federal budget on oil” — to the tune of more than 60 percent. Oil prices affect direct revenue, taxes from the industry and any economic activity generated by it. Translation? There’s fewer oily rubles for government coffers and less for re-investment in the industry, which hurts exploration and, eventually, production.
In the short term, Russia has chosen to devalue its currency to deal with the downturn, but a longer-term crisis could threaten Putin’s legacy: $385 billion in reserves. It’s this prospect that may prompt change. Like Beijing, Russia may modify its currently heavily government-controlled economy to encourage more small business. The crisis, in other words, will not be “death blow to the regime,” says Simonov.
But Robert Kahn, from the Council on Foreign Relations, thinks civil reforms are a long shot, and that further restrictions are more likely. He suspects there’s little political willingness to drive down reserves, like Russia did in the 1990s. Instead, he predicts that reserves will run down some while Russia allows its exchange rate to depreciate. This will keep interest rates high and discourage capital flight. If that fails, Kahn warns, Putin will likely “arm twist people to keep their money” at home. What’s “Say Uncle” in Russian?
To be sure, all of this may create strong economic incentives for a compromise, Kahn says. But there are great military and economic risks on the road to achieving that. The recent ceasefire for Ukraine seems a positive step but one that many experts remain skeptical will succeed in the long term, including Kahn and Simonov. Many fear that any demilitarization will be short-lived, like the previous ceasefire, and politicos will continue keeping a close eye on the Baltics for possible spillover, which would risk embroiling NATO in a much bigger conflict. The boom-bust effects, in other words, may eventually help tame an aggressive Russian bear, but not anytime soon.
The U.S. shale boom — which Obama once predicted would provide 600,000 U.S. jobs by 2020 — fueled much of this, but where will it lead? With oil companies suffering huge drops in profits worldwide, the industry risks bleeding more red than black. This is hitting the shale market with reported rig deactivations of about 100 — a week.
Even worse: Bank of America’s commodity experts predict U.S. shale growth will fade further this year, with flat output projected in 2016. Meanwhile, they expect OPEC to continue expanding production, because the sheiks in Saudi Arabia want the market to balance in their favor.
And therein lies the crux: If oil prices increase, Russia will have no reason to play nice, and ISIS revenues will jump. If prices remain low, ISIS may be pressured and Russia pushed — slowly — toward reform, but it’s risky and far from guaranteed. Meanwhile, a prolonged oil crisis may also end up dimming the brightest spark in today’s world economy: the U.S.