Tectonic shifts are taking place in the world economy. The price of oil has fallen dramatically in the past six months. The price of Brent Crude has now fallen to less than $60 a barrel. This marks a near fifty per cent drop in price from $115 a barrel in June. It heralds a new stage in the capitalist crisis, and its impact is being felt throughout the world.
The IMF’s Christine Lagarde has called this ‘good news for the global economy’. But is this really true? Cheaper oil prices should mean savings being passed on to the consumer, boosting demand and further stimulating the so-called “recovery”.
In truth the fall in oil is part of a more complicated picture. It has been caused primarily by the slowdown in the world economy, particularly China. This is the consequence of the worldwide crisis of overproduction, which in China's case had been masked by historical levels of state intervention.
$586bn was pumped into the Chinese economy in 2009 as part of a huge stimulus package, in order to “keep the plates spinning”. Huge infrastructure projects were embarked upon that maintained employment and absorbed investment.
The effects of China's adventure in Keynesianism are now coming to an end. GDP growth has slowed to around 7%. Europe and Japan, two of its main export markets, are in recession and not buying, having a knock-on effect on Chinese production.
The slowdown in the world economy signals the oncoming of a new stage in the capitalist crisis. But it also has its roots in the previous period. The fall in demand for oil has also been accompanied by an increase in supply, particularly through the development of the shale oil industry.
Shale oil, involving a more complicated and costly method of extraction, was developed in the years following the 2008 crisis, particularly in the United States. Since 2010, twenty thousand new wells have been opened up in this field - twice the rate of world oil leader Saudi Arabia.
The capital investment necessary for the opening for this new field came from the excess glut of capital that accumulated following the 2008 crash. As a result of "overcapacity", huge swathes of capital sought areas for investment outside of private industry. Hence, the stock exchange and luxury goods boom in a period of austerity and recession.
Capital also found its way into developing the shale oil industry, which had been considered financially unviable. However, this proved lucrative as China continued to motor on following its stimulus, demanding oil and allowing for a high enough price to make investment in shale attractive. In this period the development of the shale oil industry in the USA boosted production by one-third to 9m b/d (barrels per day).
The rise of US oil has now sparked a trade war with Saudi Arabia, leader of OPEC - the cartel of oil producing countries. As oil prices began to fall this summer, due to the waning strength of the world economy, the Saudis decided to embark on a tactic of not cutting production below the already agreed 30m b/d.
Under capitalism, new entrants pile into a market that is experiencing high demand and where great profits are there to be made. Typically, however, these new entrants enter with a competitive edge and equipped with the latest production techniques. As the price comes down through production, those with the most productive techniques will capture the market. While shale oil exploration represents the latest in technique, it is far from the most cost-effective. Its cost of production is higher than traditional extraction, hence the previous hesitation of investors. The “OPEC-organised” price-fall goes even below the cost of production using traditional methods. But it is the new American boys in shale who are being squeezed.
The Saudis have set out deliberately to cripple the shale oil industry. This was confirmed by Kuwait’s oil minister, Ali Al-Omair (Kuwait is a member of OPEC), who said maintaining production at existing levels was intended to hold on to market share, even if it meant that it “would negatively affect prices”, according to the Kuwaiti state news agency. OPEC is willing to take the hit, even at the cost of short-term losses.
The Saudis sit on $750bn of foreign exchange reserves, which they plans to use to ride out the price war. Oil receipts in Saudi Arabia count for 85% of exports. Despite large reserves to fall back on, $60 oil means a fiscal deficit of 14% of GDP, according to Moody's. This means attacks by the government on many of the social programmes which the regime conceded under the pressure of the Arab Revolution in 2011.
However, this is not only an economic struggle, but a game of international power politics. The development of shale oil has increased the US's share of oil production on the world market, leaving Washington more independent of Saudi Arabia concerning its energy needs. This is not to the House of Saud's liking.
Iran and Venezuela, both members of OPEC, reportedly begged the Saudis to cut production below the agreed 30m barrels a day, as the two countries need a high price of oil in order to allow for a balanced budget.
But the Saudis want to hit out at Iran, its traditional rival in the area, whose influence has been growing. Iran has been recently courted by America and de facto brought into alliance with it against ISIS. Saudi Arabia wants to drive a wedge between the US and Iran by crippling the Iranian economy, which needs an oil price of $140 b/d to balance its budget. And by bringing American shale production to the point of ruin, the Saudis can bring the US back into its sphere of influence.
"The main reason for it is a political conspiracy by certain countries against the interest of the region and the Islamic world and it is only in the interest of some other countries." Iranian President Rouhani told his cabinet on December 10th.
"It is true, as the Saudis protest, that neither they nor Opec as a whole can set the price. But do they protest too much, as they do nothing to arrest the speed of falling prices? It is not just that the oil producers’ cartel, where Saudi Arabia still rules the roost, declined to cut output at last month’s meeting. As recently as September the Saudis were actually increasing supply to a glutting market." (Financial Times, December 9th)
All this shows that the Saudis are playing a calculated game. According to the FT a senior Saudi official told US Secretary of State, John Kerry, this summer: “Isis is our [Sunni] response to your support for the Da’wa” – Da’wa being the Iranian-backed Shia Islamist ruling party of Iraq.
This OPEC-led price war appears to be proving successful for the Saudis. The Economist on December 8th predicted a raft of shale oil bankruptcies, which it says have been spending more on new wells than they have been making in profits.
The price war is also having its effect on the oil industry more generally. Oasis Petroleum and Goodrich Petroleum, two heavily indebted oil producers, have had to announce steep cuts in their planned capital spending for 2015. ConocoPhillips has announced it will cut spending by 20% next year. The consultancy 'Energy Aspects' says that 12% of global oil production would now be "uneconomic" if begun at today's prices.
On December 16th the FT warned: "Almost $1tn of spending on future oil projects is at risk after the dramatic plunge in crude prices to nearly $60 a barrel, Goldman Sachs has warned." Goldman also warns that fields representing 2.3m b/d of output by 2020 have now become uneconomic. And this does not include shale oil production, with its higher cost of production. Shares in ExxonMobil have slipped 15 per cent in the past six months, while Chevron has fallen 21 per cent and ConocoPhillips dipped 26 per cent in the same period.
Tensions in the world economy
Beyond the shale and wider oil industry, the fall in oil prices is bringing out underlying tensions in the world economy. The impact on China itself is having mixed results. Whilst it is the world's 4th largest producer of oil, its energy needs are so great that it is also an importer of oil. In the past decade, production has increased by 750,000 b/d, but consumption has risen by 3.7m b/d, underlining the colossal development of Chinese capitalism in the recent period.
China's internal contradictions are being exacerbated. Outlying resource-producing areas are losing out to lower oil prices, whilst China's energy-consuming coastal manufacturing areas are benefiting. This is increasing polarisation and putting pressure on some regional state budgets.
Already there have been strikes of teachers in the north-eastern province of Heilongjiang, which borders Siberia, home to the country’s largest oil field. Falls in the balance sheet of the local government has meant it has been unable to increase salaries, leading to an upturn in the class struggle.
In Russia oil and gas account for more than 75% of the country's exports and half of its budget revenues. The crisis of Russian capitalism has led the government to tax offshore capital, hitting out against a section of its own bourgeoisie that wished to pull its money out of the precarious Russian economy. "That campaign has become more urgent as western sanctions, falling oil prices and a plummeting currency drive capital flight to new heights and drain state coffers." (FT, November 19th)
The Russian central bank predicts capital flights of $128bn this year, double that of 2013. From June to the end of November the Russian rouble lost 27% of its value. On Dec 16th the Russian rouble suffered its biggest one-day drop since 1998, falling 20% against the dollar.
Currency devaluations among economies heavily dependent on oil exports are a feature of the current oil drop. The fall means the rouble has lost half its value against the dollar this year, making it the worst performing major currency, ahead of the Ukrainian hryvnia.
In response the Russian government ramped up interest rates to 17% in an attempt to curb inflation and devaluation. The Russian central bank warned that the country could see a 4.5 per cent to 4.7 per cent contraction in GDP next year if oil prices remained at $60.
The fall in the Rouble increases the burden of the $600bn debt owed by Russian banks and companies to foreign creditors. The Western sanctions imposed as part of the conflict over the Ukraine mean that the difficulty of re-financing this debt is increased. Inflation is predicted to reach 10% by the end of the year.
Crisis in Europe
The fallout has affected the Ukraine also, where Chevron has pulled out of its proposed shale gas project. “With oil prices falling, not so great geological findings in nearby countries coming in and Ukraine country-risk surging with the war as well as economic instability, it is clear now that the much hoped for shale gas boom and associated multibillion-dollar investments will not materialise,” said Dmytro Marunich, a Ukrainian energy analyst.
This is part of the flight of capital seen in Russia, which is a response to the crisis and exacerbates it further. Earlier this month, the IMF said there was a $15bn shortfall in its $17bn bailout for Ukraine. In return for meeting this shortfall, Western governments will demand more in "reforms", i.e. cuts to the cost of labour in Ukraine.
As a net oil consumer, falling oil prices means falling inflation in the eurozone. However, EU leaders were hoping for higher inflation to erode the large national debts their economies are saddled with. The spectre of deflation even haunts Europe, as the FT noted on December 16th: "Oxford Economies estimates that with an oil price of $60 a barrel, 13 European countries will see their inflation rates fall below zero, at least temporarily, in 2015... The EU imports 88 per cent of its oil but its celebrations over plunging prices have been muted."
"But Mr Draghi [President of the European Central Bank] is also quick to identify the risks when the EU already fears that inflation is alarmingly low and could be veering towards deflation. Many countries have looked to inflation to alleviate the debt burden that is restraining their spending power. Mr Draghi warned that low oil prices could become “embedded” in low wages."
In Britain, oil companies are demanding tax reforms to encourage investment, or threatening to go elsewhere. Malcom Webb, chief executive of Oil & Gas UK, warned the UK government that without tax cuts “swaths of the UK continental shelf will be pushed into terminal decline”. He demands a reverse of the 12 percentage point increase in the supplementary charge in the 2011 Budget, which raised oil companies’ top marginal tax rate to 81 per cent. Falling revenue from North Sea oil has pushed borrowing up for the UK government. British capitalism seeks to subsidise its oil industry by adding the cost to the next round of austerity cuts.
In Libya, civil war has halved oil production to 800,000 barrels a day, but this has done little to stem the price slide. Depressed oil prices have caused the budget deficit to balloon to half of GDP. Mohammed El Qorchi, of the IMF says that Libya needs prices at $135 at current production levels to balance its budget, well above the current price. On December 15th, heavy fighting led to the closure of the 350,000 barrel a day at the Es Sider terminal, putting further strain on Libya's economy.
Nigeria depends on oil for 80% of its revenue. It has set a budget of $78 a barrel a day for its 2015 budget, and has an election coming up in February. At the end of October it announced, as oil prices fell, that it could live off savings for no more than three months. On December 8th Nigeria's currency, the Naira, fell to a record low of 187 per US dollar, stoking the potential for inflation which will hit the poorest Nigerians hardest.
Impact in Latin America
In Mexico, the state has plans to sell off 169 oil and gas blocks in 2015. A feature of the bankruptcy of the state, following the 2008 crisis, is the inability to finance investment. Another is the increased pressure of finance capital on governments to privatise state assets.
With huge amounts of capital sitting idle owing to the lack of profitable areas in the private sector, capitalism turns its greedy eye ever more attentively on the state. Mexican oil has been state owned for 80 years, a gain of the revolutionary period. Once again this particular form of asset-stripping - at the state level - reveals the cannibalistic nature of capitalism in decline. Capitalism can no longer afford the gains of the past and must instead claw them back.
However, this process is now on hold in Mexico. The privatisation plans of President Peña Nieto, who Time magazine dubbed at the beginning of 2014 the “Man who saved Mexico”, have stalled: "...oil companies, with their constrained budgets, will probably be more selective about what they bid for and might trim their offers, putting the government under pressure to sweeten terms." (FT December 9th)
As with the Ukraine, by 'sweeten terms', capitalism means to attract investment by making Mexican workers pay for it: by reducing wages and welfare, as well as using the tax revenues gained from ordinary Mexicans to subsidise the oil companies' investments.
With a mass movement erupting in recent months however, the Mexican workers will not be so easy to pacify in order to "sweeten terms" for the oil companies. The Peso has also dropped 10% in the past four weeks, which will only fan the flames of the movements of the Mexican masses.
According to BP, Venezuela has the largest oil reserves in the world. Oil accounts for 95% of export revenue and inflation is running at 60%. The IMF expects the economy to shrink by 3% this year. Analysts say the country can get by so long as oil does not fall below $80 a barrel. On December 11th, Venezuelan debt surpassed Argentina's, which defaulted earlier this year, to make it the most expensive in the world. The cost of insuring Venezuela's debt has quadrupled since June.
"The collapse in the Bolívar, which has fallen more than 120 per cent over the past four months to 178 per dollar in the black market, combined with soaring inflation and bond yields, suggest Venezuela is in an economic crisis”, says Capital Economics. Analysts at Ecoanalítica, a Caracas-based consultancy, estimate that the country needs a Brent price of above $130 to balance its budget - more than double the current market price.
On December 8th, the US dollar reached its highest point since the 2008 financial crisis. While the US' shale industry is hit, falling oil prices puts $75bn into the market. It is the equivalent of 0.7% of total US consumption. The Economist estimates the average US motorist should save $800 a year, equivalent to a 2% pay rise.
The US is temporarily pulling away from the rest of the world. However, this cannot go on indefinitely as the USA is tied to the world market and cannot escape the orbit of the black hole of capitalism. “Even in the US, there is sensitivity to the global level of slack in economies. It is not enough to be growing fast if the rest of the world is not doing the same", says Gilles Moec, European economist at Bank of America Merrill Lynch.
In a sign of how the slump in the price of oil threatens to infect the banking and financial system, Barclays and Wells Fargo are now facing heavy losses on an $850m loan made to two US oil groups, Sabine and Forest. They cannot find a buyer for the loan, which now weighs heavily on the banks' balance sheets.
The banks have been financing the expansion of the energy industry. As a result Marty Fridson, chief investment officer at LLF Advisors, says 30% of "distressed bonds" are issued by the energy sector. According to Barclays, energy bonds make up 15% of the junk bond market, compared to 4.3% a decade ago.
Owing to weak demand in China and Europe, some are predicting that $60 (or less) oil is here to stay. Others are looking at the slump in oil and drawing parallels with the 2008 crisis:
"...there is a stark parallel with the US property market collapse that heralded the start of the 2008 global financial crisis — and upended banks along the way. Those lenders with oil exposure on their books may well be stuck with big losses. Yet the banks with the biggest stakes in this high-risk market are among the most prized by investors. Wells Fargo is one of the most highly valued banks in the world, enjoying a share price rise of 23 per cent this year. It is tempting to think that — like the other darlings of the post-crisis banking market, notably Standard Chartered and BNP Paribas — it is overdue a fall from grace." (FT, December 16th)
The fall in oil has confounded bourgeois strategists, who, if anything, had anticipated a spike in oil prices as a consequence of political conflicts and tensions in the Middle East, North Africa and Ukraine.
Ordinarily a falling price of oil should serve net consumers of oil, such as the eurozone and Japan. A $40 fall in the price of oil represents a $1.3trn shift in the world economy from producers to consumers.
However, the picture is not so simple. For net consumers, cheaper oil dampens inflation. Already in the EU predictions show that it will not reach its 2% inflation target. When states such as the EU and Japan hold massive debts on their balance sheets, inflation is seen by the strategists of capital as a necessary evil by which to erode away the value of the debt.
In the short-term, the rise of the dollar at the expense of other economies harms many of the so-called "emerging markets", who hold a lot of their debt in dollars. For these economies the price of their debts have just become more expensive
Economies almost wholly depend on oil exports, such as Russia, Venezuela and Iran, are tied to the fate of the price oil. These regimes, to the delight of US imperialism first and foremost, are set to be hit hardest. As the value of these economies falls with oil, so their currencies devalue, causing rising prices on imports and hitting those on the margins of the economy most severely.
Russia in particular appears now as a giant with feet of clay as its economy enters freefall. Sergey Shvestov, deputy governor of Russia’s central bank, said the situation was critical: “I couldn’t imagine even a year ago that such a thing could happen, even in my worst nightmares.” (FT, December 17th)
Cross currents and turbulent times ahead
Despite many cross currents in the world economy, and what has become the typical schizophrenic reaction by the bourgeoisie as they are tossed on the ocean of the capitalist crisis, the December 16th edition of the Financial Times summed up the situation well:
"The 40 per cent drop in the oil price to around $60 a barrel since June is by far the biggest shock for the global economy this year. Similar episodes in the past tell us the consequences are likely to be both profound and long lasting. Normally, economists would add “positive” to this list, but doubts are surfacing as never before. The scale of the current oil shock is difficult to exaggerate."
For Marxists, the reading of the economy is only useful in that it helps us understand what effects these developments will have on the class struggle. This new stage in the crisis opens up a new period of struggle. The period 2008-14 has burnt away many of the illusions once held towards capitalism. The coming period, which promises to be even more turbulent, will put the working class internationally on the road to revolution.