Petroleum

The Dire Consequences of Collapsing Oil Prices

Oil Price Volatility

The global oil industry has experienced four significant oil price crashes since the formation of the Organization of the Petroleum Exporting Countries (OPEC). The threat of prolonged periods of low oil and gas prices poses significant economic implications for the entire global economy, not just the oil and gas producers themselves. While oil and gas producers are without a doubt among the first companies to be immediately impacted from a drop in crude oil prices, various economic shockwaves can often be felt throughout global markets. Over the past three decades, advanced economies in developed nations have experienced a substantial increase in oil price volatility. Quantifying the socioeconomic risks of oil price volatility has become a prominent topic that policy makers, investors, and economists have attempted to evaluate over the years. Repeated oil price spikes and dramatic crashes have a wide array of global impacts that are pivotal to understand.

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Driving Economic Growth and Geopolitics

The price of oil has the ability to drive economic growth and influence geopolitics. Global alliances and economic partnerships rise and fall over the price of oil. When oil prices are high, nations that rely on fossil fuel revenue are able to adequately fund their governments and social programs. Moreover, when oil prices are high, studies have shown that Middle Eastern nations experience more periods of stability. Other studies have shown how oil revenue can also function to prop up extremist groups in countries like Nigeria and Iraq.

From a domestic standpoint, high oil prices incentivize the use of alternative modes of transportation and prompt investments in renewable forms of energy. It also has encouraged the development of more costly forms of fossil fuel extraction, like tar sands production and the shale oil boom in West Texas. Conversely, when oil prices collapse, profound consequences are experienced all over the world, with the potential to dramatically undermine nations that are dependent on fossil fuels.

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The 1980s Oil Price Crash

The first oil price crash occurred in the mid-1980s. Prior to this period of time, fossil fuel consumption and economic growth rates followed each other in unison. However, as efficiency improvements were made and energy-intensive industries were exported to the Global South, economic growth rates in developed countries started to surpass the rate of fossil fuel consumption. The opposite was true with less developed countries. With this in mind, most statistical comparisons of gross domestic product (GDP) and fossil fuel consumption do not indicate strong levels of correlation (Pirani, 2018).

The 1980s proved to be a unique time for global fossil fuel consumption. While the memory of the OPEC-induced oil price surge during the 1970s was still in the back of policy makers’ minds, strong market responses to this incident ended up pushing global oil prices down significantly. When the OPEC cartel worked collaboratively to quadruple oil prices from $3 a barrel to $12 dollars a barrel, world leaders vowed to identify strategies to prevent future instances of price gouging. As huge new oil reserves were discovered and non-OPEC oil production surged, the price of oil collapsed. The creation of massive new fields in the North Sea and in Alaska counteracted OPEC’s ability to control oil prices. Moreover, fuel efficiency standards also started to gain momentum during the 1980s, following the panic that was generated from a lack of oil during the 1970s.

In addition to the discovery of new oil reserves and enhanced fuel efficiency standards, the OPEC cartel could not come to an agreement to cut oil production, which further exacerbated the decline in oil prices. This period of low oil prices proved to have a particularly long-lasting impact on the global economy, with prices only rising modestly up through the early 2000s. Following the 1970s energy crisis, global efforts related to energy conservation and new energy exploration contributed to the 1980s oil glut. Reduced demand and increased production greatly benefited oil-consuming countries in Europe, North America, and Japan. On the other hand, the Middle East and the Soviet Union suffered immensely from a drop in oil revenue.

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The Great Recession Price Crash

The next dramatic oil price collapse occurred in 2008. While changes related to the supply and demand of oil around the turn of the century started to increase oil prices, the onset of the Great Recession initiated a rapid collapse. Prior to the beginning of the 2008 collapse, new supplies of oil were beginning to be increasingly difficult to find. Meanwhile, as war started to interrupt Middle Eastern oil production, and the demand for oil in countries like China and India started to accelerate, oil prices rose well above $100. In 2008, the price of oil rocketed to more than double the average price of oil in 2007 (Teslik, 2019). Although, they crashed below $40 a barrel just as rapidly as they had risen.

As economies around the world collapsed during the 2008 financial crisis, oil prices followed. Oil prices reached historic highs of $144.29 in July 2008. However, only five months later, they had collapsed to $33.87. In response to the dramatic and unprecedented downfall, OPEC slashed production by 16 percent over the course of the next eight months in an attempt to add some stability to global oil prices. Following production cuts, oil prices rebounded back above $50 per barrel in a short four-month period. As China’s demand for fossil fuels started to rebound, so did the price of oil. By 2012, global oil prices were back above $100 a barrel. However, only four years later, prices collapsed again.

Oil Supply Glut Crash

Between June 2014 and January 2015, the WTI and Brent crude oil prices each fell by 60 percent (Fantazzini, 2016). New oil and gas discoveries, coupled with rapidly improving technology related to hydraulic fracking and oil drilling, created a global oil supply glut in 2014. Massive new reserves of accessible and dependable sources of oil eased global concerns about a future energy-related crisis. Instead, surging oil inventories reduced gas and diesel prices for manufacturers and consumers but had an undesirable impact on economic activity and jobs within the fossil fuel industry. The oil-supply outlook in 2014 and 2015 represented a clear departure from the outlook that was projected in the early 2000s. During this period of time, producers struggled to keep up with the increasing demand in China, crude prices skyrocketed, and energy analysts outlined dire peak oil scenarios (Krauss, 2019). The subsequent surge in U.S. oil production set these fears to rest.

In 2014 and 2015, financial investments in the extraction and production of oil, gas, and coal reached $580 billion, dwarfing all other energy-related investment flows (Pirani, 2018). The resurgence of fossil fuel discoveries and new extraction technology following the Great Recession of 2008 helped to propel the world out of the global economic slowdown. Advanced hydraulic fracking, horizontal drilling, and deep-water oil extraction became common practices throughout the oil and gas industry. These technologies fueled new production and caused the price of oil to fall substantially.

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Coronavirus and Price War

Following the surge in oil and gas production in 2014 and 2015, prices barely stabilized before collapsing again in early 2020. As fears started to mount related to the economic impact of the coronavirus outbreak, global economic markets became paralyzed. Since oil consumption is tied to economic growth, a paralyzed global economy stunted growth in fossil fuel industry. Toward the end of 2019, oil prices started to take a significant hit as virus fears reduced the global demand for energy. To make matters worse, an oil price war between Russia and Saudi Arabia erupted in March of 2020, which caused oil prices to collapse by 34 percent overnight. The crude oil price collapse of 2020 compelled energy analysts and economists to revisit previous price collapse scenarios that have been experienced throughout history. In order to evaluate impending economic impacts, it’s vital to reexamine the past to predict the future.

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Dependence on Oil Wealth

While crude oil prices are notoriously challenging to predict, the impact that low oil prices will have on the economy is a phenomenon that has been experienced numerous times throughout history. With low oil prices, investments in oil extraction technology fall significantly. Conversely, any oil price rebound would re-energize oil and gas producers, particularly those that work in cost-burdened sectors like the U.S. shale industry. From a geopolitical standpoint, the impact of low oil prices has traditionally been the strongest among oil-producing countries in the Middle East, who depend on oil revenue to continually invest funds in social programs and other initiatives to discourage social unrest. The Middle Eastern political structures are particularly fragile and depend on oil wealth to support economic growth. When that oil wealth disappears, the ability for Middle Eastern countries to address socioeconomic challenges diminishes significantly.

Professionals with backgrounds in international relations seem to agree that low oil prices are a catalyst for increasing levels of global conflict. Terry Lynn Karl, professor of Political Science at Stanford University and author of the well-known book The Paradox of Plenty: Oil Booms and Petrostates, has said that a significant drop in global oil prices may be catastrophic for fragile governments that depend on oil revenue. Moreover, while low oil prices were once thought to be beneficial for the economy and the stock market, most economists now refute this notion. In the U.S., low prices have led to huge budget cuts in Texas, North Dakota, Louisiana, Alaska, California, and New Mexico, which amounted to a $300 billion decline in capital investment in 2016 alone (McLaughlin et al, 2016). Energy company bankruptcies and the undercutting of incentives to propel alternative energy generation have also been impacted.

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Renewable Energy Impact

Some economists believe that low oil prices may actually strengthen the long-term prospects for alternative energy generation. Dan Esty, a Hillhouse professor at Yale University, says that the market for alternative energy has various supply and demand forces that influence the flow of investment into solar arrays, wind turbines, and other renewable energy projects. Instead of simply making investments in alternative forms of energy when oil prices are high, Esty says that clean-energy markets do not depend on high fossil fuels prices. Instead, forces like the 2015 Paris Climate Agreement will continue to drive renewable energy investments, regardless of fossil fuel prices.

The Big Picture

Overall, the collapse of oil prices can have a massive impact on the global economy. While the average consumer may celebrate the low prices for gasoline and diesel, the hidden economic consequences of sinking oil prices can create havoc throughout many economic sectors. While countries that are dependent on oil revenue may be able to absorb some of the short-term economic pain from low oil prices, long-term periods of depressed oil prices may have lasting geopolitical implications.

Sources

Aboura, S., and Chevallier, J. (2015). “Spikes and crashes in the oil market.” Journal of Research in International Business and Finance: Vol. 36, No. 1, pp. 615-623.

Fantazzini, D. (2016). “The oil price crash in 2014/15: Was there a (negative) financial bubble?” The Journal of Energy Policy: Vol. 96, No. 1, pp. 383-396.

George, P. (2016). “What Past Oil Crashes Say About Today’s Slump.” Fortune.

Halff, A. (2007). “The Oil Market after the Crash: Old Fears, New Risks.” The Journal of Energy and Development: Vol. 33, No. 1, pp. 91-103.

Kalyanaraman, A. (2020). “Crude oil crash: Who gains and who loses.” Hindu Business Line.

Krauss, C. (2019). “Flood of Oil Is Coming, Complicating Efforts to Fight Global Warming.” The New York Times.

McLaughlin, J., et al. (2016). “The Hidden Consequences of the Oil Crash.” Politico Magazine.

Ploeg, F. (2016). “Fossil Fuel Producers Under Threat.” Oxford Review of Economic Policy: Vol 32, No. 2, pp. 206–222.

Pirani, S. (2018). “Burning Up: A Global History of Fossil Fuel Consumption.” Pluto Press: London.

Teslik, L. (2019). “The Future of Fossil Fuel.” Encyclopedia Britannica.

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