Oil Prices: Central Planners Are Only Delaying an Economic Collapse

Oil PricesRussia, Saudi Arabia, Qatar, and Venezuela have agreed to freeze production. Will this finally help to support oil prices? Not yet. Skepticism abounds. Even if Saudi Arabia and Russia have agreed to freeze oil production, the markets had expected an actual cut in production. The current arrangement provides for a less exciting prospect. The four countries are not to exceed January 2016 production. Regardless of cuts, the gains are short-term and the risk of economic collapse remains.

The ministers discussed measures to support the market a one-and-a-half years after the price of crude fell by two-thirds. The price ended at $30.00 a barrel, its lowest level in 13 years.

Despite the enormous losses that oil producers have endured, and even after some $400 billion in investments have evaporated, the market is not yet close to a breakthrough. The decrease in production still represents a step forward: better than nothing. Whether this “minimalist” agreement holds is another matter. So far, the international benchmark Brent crude surged more than five percent to reach $35.00 per barrel. It settled at $34.00 per barrel.

The optimists see the deal as a constructive first step. After keeping the taps running on high for the past 18 months, the fact that Russia and OPEC have eased their war to secure market share and force out rivals, if only by a little, can restore some balance to the market. (Source: “Oil price: Saudi Arabia and Russia reach supply deal – but will it be enough?” The Week, February 16, 2016.)

One of the question marks remains: Iran. Russia’s ally in geopolitics but a market rival for oil, Iran, which just emerged from a three-and-a-half decade-long “time out” has just delivered its first oil shipment to Europe. The agreement is all the more remarkable because Saudi Arabia and Russia are at risk of fighting each other in Syria now. Saudi Arabia and Turkey are considering deploying ground forces in Syria to fight the very same militias, getting tactical and battle support from Russia.

Iran’s oil production contributes to the two million barrels per day of excess supply. Iran confirmed that it would not give up any of its global oil market share.

Iran’s oil minister, Bijan Zanganeh, said that while the market is facing a surplus, he stressed that his country would not join in the cuts. Zanganeh will meet with the ministers of Venezuela and Iraq in Tehran on February 17, but Iran’s goal is to increase production, targeting pre-sanctions levels. Iran expects Japan to reach that target soon. (Source: “Iran Ships First Oil to E.U., Seeks Growth in Japan,” The Maritime Executive, February 15, 2016.)

Meanwhile, Saudi Arabia produced 10.2 million barrels per day in January, according to the International Energy Agency (IEA). Russia produced nearly 10.9 million barrels per day in the same month. Qatar Energy Minister and current OPEC President Mohammed bin Saleh al-Sada said that the country would monitor the production freeze agreement.

Russia might be struggling, but Venezuela is suffering. Its own oil minister, Eulogio del Pino, took a tour of the main oil-producing countries. He promoted the idea of freezing output to stop prices from falling further. If there is an optimistic lining, a hint that oil prices will reverse the bearish trend this year, it is that the parties agreed that this is but a first step. The Saudis, in particular, will evaluate what tools, if any others, it can use to stabilize the market.

Nations like Saudi Arabia and the United Arab Emirates (UAE) said they have been waiting for the invisible hand of the market rather than production cuts to reduce supply. Their goal has been to crush oil sales from higher-cost extractors and producers like the U.S.

The Situation in Syria Is the Obstacle

If the geopolitics surrounding the conflict in Syria worsen, oil prices will suffer to the point of a market meltdown. Both Turkey and Saudi Arabia have made it known that they are ready to carry out ground operations to “restore calm” in the country. In fact, the goal of the Turks and the Saudis actually seems more to overthrow the al-Assad regime. For their part, President al-Assad’s allies, such as Russia and Iran, have warned Saudi Arabia not to interfere in the Syrian issue.

Both the United States and its allies (Saudi Arabia and Turkey) and Russia and Iran claim to be aiming for the destruction of the Islamic State. The U.S. camp wants to eliminate al-Assad in the process. Russia wants to restore the reach of his political and military power.

None of the countries is willing to risk cutting production without the highest assurances that competing nations will do likewise. They incur the risk of losing further market share if they make a cut alone. This applies as much to Russia as it does to the UAE, Brazil, Mexico, Venezuela, and the United States. Syrian tensions do nothing but feed the already intense disagreements between these countries, thus removing the possibility of a production cut.

Yet, the one “hope” is for OPEC to realize that there is less demand, even at low prices. At that point, it will adopt more far-reaching cuts.

China has grown below expectations and has reduced crude oil demand by 20%. Cutting production would not resolve the oil price issue by itself. A cut like that would allow higher-cost producers to experience short-term relief. The lower the prices dips, the more oil-producing countries worry and swiftly move to attempt cutting production.

In the short-term, the recent wave of overproduction has reached such an extent that it will take time for prices to reach stability. Global demand is slowing, given the sluggish economic situation. The collapse of shale and oil sands extraction in the U.S. and Canada is around the corner. This has increased the likelihood of a recession here in America and our northern neighbor, as well as other countries due to the “contagion” effect.

Lower oil prices have also contributed to all-around deflation. Many central banks are trying to confront the issue with ever-lower interest rates. This will unravel monetary policies and reduce bankers’ effectiveness in steering the economy. The best that can occur is for low oil prices to push industrialized countries toward structural reforms. Rather, now, the only solution has been to use mere liquidity floods—which are at the heart of speculative bubbles.